Value Investing

Matthew Frederick: Three Levels of Knowing

Everyone likes a simple investment idea, but don’t confuse simplicity with laziness. I’ve had this view for quite some time; only I couldn’t think of the best way of expressing it. That changed when I saw this Farnam Street article on the Three Levels of Knowing which really struck a chord.

Three Levels of Knowing


From the article, the three levels of knowing are as follows:

  • Simplicity is the world view of the child or uninformed adult, fully engaged in his own experience and happily unaware of what lies beneath the surface of immediate reality.
  • Complexity characterizes the ordinary adult world view. It is characterized by an awareness of complex systems in nature and society but an inability to discern clarifying patterns and connections.
  • Informed Simplicity is an enlightened view of reality. It is founded on ability to discern or create clarifying patterns with complex mixtures. Pattern recognition is a crucial skill for an architect, who must create a highly ordered building amid many competing and frequently nebulous design considerations.

Applications to Investing

As investors, it is imperative to recognise the difference between simplicity and informed simplicity in an idea. It is the same difference between being ignorantly simplistic and being elegantly simple. A simple investor is an ignorant one, someone who shuns complexity and doesn’t make the effort in assimilating or synthesizing information. Instead, he dismisses them with a lazy notion that it is ‘too much’. The risk of his investment will be high because of the degree of unknown unknowns.

True, there may be times when it is ‘too much’. But everyone starts with simplicity. It is only through the mental exercise of analysis and making mistakes that we stretch ourselves, over time, into grasping complexity, and then finally, to informed simplicity in our investment ideas.

A maestro of informed simplicity is Warren Buffett, cliché as it may seem. His ideas and views and conveyed with elegant simplicity, but he is anything but a simple man. There is much introspection that supports the rigour of his apparent simplicity.

I can recount my experience with the CFA Research Challenge where every team is supposed to make a 10 minute investment pitch. Needless to say, everyone was aiming to win and much effort was put into researching the chosen companies. With that, everyone was able to recognise the complexity of the issues surrounding the companies. The natural instinct for most teams would be to cram and rattle off as much relevant information about the company as possible within the 10 minutes. However, the greatest challenge – and what demonstrates true mastery – is to apply Occam’s Razor to the ideas. Occam’s Razor is a principle which holds that the simplest answer is probably the correct one. To give a gruesome analogy – complexity is to bludgeon a person to death with many blows; informed simplicity is a clean stab through the heart.

Besides investments, the three levels of knowing also apply to writing. A simple writer is one who gets the technicality of writing right. The complex writer is one who takes pride in adding sophisticated vocabulary (we have all been there). But the best writers are the ones who are able to describe with incisiveness, yet without any loss of details.

Final Words

In my admittedly short experience, I have come to realise that the simple investor and the complex investor are the common. The simple investor – because not everyone has the desire to master the art of investing. But there are those who do, yet they remain simple because of laziness. Then, there are complex investors. These are usually the more dedicated investors which include professionals. They are usually unable to hit the level of informed simplicity because of its sheer difficulty. Indeed, I do not think it is possible to have informed simplicity on every subject and idea. However, what would be most unfortunate would be if they had the misperception that informed simplicity is simplicity, and complexity allows them to sound smart.