a question that always comes up when reviewing a bad investment. Seldom, people ask this question when an investment or decision worked out, and almost never do they ask how much of the positive outcome is actually attributable to luck.
Diaries are a good way to not only analyze where you have made mistakes in the past, and why other things worked out, but also to understand when a bad outcome was actually achieved with a sound process (bad luck), and when a good outcome was driven by factors you did not even consider (luck).
Use a Range of Mental Models
The key here is looking at the issue from many different perspectives. Don’t do this sporadically, but make a list of mental models. Apply this list to difficult problems and important decisions, treat it as an exercise and evolve it into a habit. It will require you to frame problems in different ways, reframe questions, and simplify.
Building and maintaining a list of mental models is a life-long exercise, and a whole topic in itself. Once again, I resort to other resources. First of all, Charlie Munger presents a comprehensive list of mental models. The list of mental models might be to some degree overlapping with perspectives of the bias checklist.
An investor’s mental model list should certainly include:
- Logic, number, and probability based thinking like that of a mathematician, physicist, engineer, accountant, Nassim Taleb (whatever he is)
- Social problem solving tools e.g. the perspective of a psychologist
- Natural sciences, particularly biology
- Business perspective
Subsets of these mental models are incredibly powerful problem solving tools. For example, inversion, or adopting the perspective of smart people holding the opposing view. This is sometimes called “playing devil’s advocate”. You really want to think about what you are missing, and seek to disconfirm yourself. You should welcome opposing arguments or views on an investment, specifically from those you know to be the most well informed or educated on an investment. You are certainly not as well trained as a professional psychologist, or mathematician, but you want to foster the little mathematician, physicist, or philosopher in you and soon you will find that the big ideas are mostly covered in rather elementary material. As an added bonus, you will simply learn more about more topics over time.
I like to imagine myself in different roles, similar to what an actor would do. I like to try to think like people from different professions and backgrounds. For example, I’ll imagine myself to be a psychologist, mostly ignorant of mathematical problem solving tools on one day. The next day, I pretend to be a mathematician and accountant working together to solve the problem. Another day, I may prepare a presentation to short the stock I want to buy. To make it more fun, I sometimes act as if I was, or could ask, a person of history or great fame.
Religious Christians might ask “What Would Jesus Do?” for moral guidance. Maybe, as an investor, you should ask yourself more often what Charlie Munger, Warren Buffett, or Benjamin Franklin would do, or how they would view a situation. The book “Think and Grow Rich” introduces the idea of an invisible council – a group of people you would love to consult on a problem. Visualize this group of people sitting in a circle with you and imagine them answering your questions. Of course, the characters you imagine will be as you make them up to be. You may find yourself truly shocked when a member of your invisible council gives an answer that seems to truly surprise you.
Precommit
Benjamin Franklin is quoted saying “An ounce of prevention is worth a pound of cure.” Precommitment is related to this idea, despite the fact that the word precommitment makes no sense to me. Because you accepted that you cannot rely on your decision making apparatus in the heat of the moment, you make the decision at an earlier point when you can think more rationally. The great Sir John Templeton believed heavily in commitment, and kept a list of stocks with price thresholds under which he would buy the stock no matter what.
One of the first important commitments you want to make is a commitment to rational thinking, or at least, the aspiration of it. Commit to going through your checklists, and other tools and tricks that should help you think more rationally, instead of reaching the easily available conclusion. Maybe more importantly, commit to not doing other things, like trading on an idea the same week that you hear about it.
Your commitments should be written down, and items should be only adjusted if practically not achievable, or when the evidence has clearly changed. Overcome the impulse to start off with an extensive list of commitments, as every commitment limits your flexibility. Also, once you break the first commitment, it becomes easier for you to break subsequent ones, so use them sparsely.
Limit Options and Noise
Limiting options and noise is a tool that helps you not do some things, which is hugely important (see Franklin’s quote above). Studies have found that people that superficially exercise more discipline, partly seem to do so because they never consider some of the bad behaviors as available options, which puts less stress on their brain to force it to behave well. Limiting options works on psychological levels, as well as on physical levels. You could for example say that you will never renegotiate a price once you made a firm offer. This will not only make it easier for you, because you know you will never have to go through tough negotiations, it will also make it more likely for your counterparts to accept the offer, because they run the risk of breaking the deal if they try to lower the price. Limiting options can be in many regards a helpful tool as students of game theory will understand.
On a different level, you can simply seclude yourself from the noise of the financial media and the talking heads. You can, to a huge degree, influence your environment, where you live, what kind of people you interact with. I admire people like Guy Spier who show the integrity to move to a more secluded location to limit options and noise. You don’t have to go so far yet. Start by switching off the TV. Next, stop checking your stock prices on a daily basis (you can still follow the news).
Process Focus
This is not really a tool, but a mindset. However, I believe it is worthwhile briefly highlighting separately because it might be one of the most important pieces of the puzzle.
Be processed focused. You cannot control outcomes, and there are imponderables. What you can control is what you do. Wisely distinguish between what you can influence and what you cannot. Distinguish between something that you had missed, and something that was not realistically considerable at the point in time when you made the decision. The more randomness is involved in the outcome, the less linear the feedback will be, and consequentially the more you will have to focus on the process instead of taking short term results at face value. This presents a difficult problem, because optimization of the process requires some feedback,
