Podcast Summary
Understanding the Human Motivation for Resolving Uncertainty and Investing Strategically: Humans have a natural inclination to seek certainty and resolve uncertainty. As investors, we should recognize this tendency and use mental models to make smarter investment decisions. Enjoy a bit of uncertainty, but understand how to manage it wisely.
Humans are hardwired to shy away from uncertainty. Our quest for certainty, to resolve uncertainty is a primary human motive. Recognizing patterns gives a survival advantage, and we become anxious when we can't recognize a pattern. Resolving uncertainty triggers our relaxation response and releases dopamine which feels good. Our relationship with uncertainty is not straightforward; we actually like a bit because we love how it feels when we resolve it. This is why some people like to gamble or watch movies without knowing the ending. As investors, we should recognize this natural human tendency and use mental models to invest more intelligently.
Mental Models and the Benefits of Hanlan's Razor.: Mental models can help individuals make better decisions by providing a framework for understanding situations. Using Hanlan's Razor can prevent unnecessary negative emotions in response to uncertain or ambiguous situations.
Humans dislike uncertainty as it causes stress and psychological agony. This was shown in a study where volunteers were shocked randomly and were more stressed when they couldn't see a pattern to avoid the shocks. Mental models help create a framework for understanding how the world works in specific instances. Without the correct mental models, people can make bad decisions based on emotions or inaccurate information. A helpful mental model is Hanlan's Razor, which advises not to attribute malice to actions that can be explained by stupidity, carelessness, or sloth. Applying this model can prevent feelings of hurt or anger when emails go unanswered or meetings get canceled.
How to Deal with Uncertainty like a Great Investor: Recognize and own your feelings of uncertainty, rely on true mental models, avoid cognitive closure, be comfortable with uncertainty, and know that having no explanation is okay.
One of the best ways to deal with uncertainty is to recognize when you're feeling uncertain and to own it. This quest for certainty can drive a lot of our behavior, even if we don't realize it. Great investors have a lattice work of mental models that they fall back on that are true, and they know which ones to pull out when. And we can have opinions, but we shouldn't go all in. We need to recognize the need for cognitive closure when we feel uncertain, and avoid becoming hyper-vigilant where we look for answers. Instead, we should focus on being comfortable with uncertainty and realize that we don't always have to have an explanation.
Overcoming Bias and Embracing Uncertainty.: In uncertain situations, avoid becoming overconfident in beliefs. Seek productive information, be open to different viewpoints, and recognize the world as fundamentally uncertain.
When faced with uncertainty, we tend to seize and freeze on the first explanation that fits our worldview and become information junkies, seeking dopamine hits from taking in more information. We also turn to experts for predictions and seek out groups that think like us, creating echo chambers. However, this behavior can be counterproductive when faced with unknowable situations. It's important to recognize that the world is fundamentally uncertain and to avoid becoming overconfident in our beliefs. Instead, we should strive to seek productive information and be open to other points of view to develop a well-rounded understanding of the situation.
The dangers of jumping to conclusions and the importance of embracing uncertainty.: Avoid oversimplifying issues and assuming causation without evidence. Embrace the possibility of being wrong and seek out diverse perspectives to broaden understanding.
Humans are prone to quickly jumping to conclusions that are too simplified or not true because of their dislike of uncertainty and the need for an explanation. Correlation does not equal causation, and there can be a common cause that explains the correlation. The example of children's academic performance and the number of books in their household showed that having books did not cause higher educational attainment; it was a symptom of the type of parents that bought books. It is essential to position ourselves for uncertainty and consider the possibility that we may be wrong. We should surround ourselves with diverse opinions and media, not just those that align with our beliefs.
The Debate on Female-led Companies and Performance: While research shows a potential link between strong female leadership and high performance, it's important to recognize that causality is not always clear. It's also essential to avoid overestimating coincidences as meaningful when investing.
There is a debate about whether or not female-led companies have better performance. Although some research shows that there might be a causal link between strong female leadership and high performance, others suggest that the causality may be the opposite and it is a symptom. So far, there haven't been any longitudinal studies between companies to tease this out. It is also essential to understand as an investor that highly improbable scenarios are actually to be expected, and coincidences don't necessarily indicate a greater meaning in the world. This topic can be considered a buzzkill for some people who look at coincidences as a way to find more profound meaning in life.
The Role of Coincidence in Investing: Expect the unexpected and prepare for improbable scenarios by diversifying your portfolio. Don't assume the stock market reflects the economy - it's important to understand the difference. Don't read too much into patterns that may just be coincidence.
The highly improbable happens all the time, and we as humans tend to be surprised almost every time it happens. Coincidences may occur more often than we think, and we should not read too much into patterns that are not grounded in anything other than randomness and chance. This mental model has implications for investing, as we should account for the improbable scenarios and diversify our portfolios to protect against unexpected events. The stock market is not the economy and its performance may not always reflect the state of the overall economy. Therefore, it is important to not make oversimplified assumptions about the stock market based on the state of the economy.
The Uncorrelated Relationship between the Stock Market and Economy: Understanding that the stock market and economy are not directly related can help investors make more informed decisions by managing their expectations and acknowledging that there is no surefire strategy for investing. Adaptability is key in an ever-changing landscape.
The stock market and the economy are uncorrelated, meaning that the stock market doesn't directly reflect what's happening in the economy. In fact, the stock market often predicts what the economy will do, but the economy doesn't predict what the stock market will do. This means that economic indicators like GDP growth, interest rates, and corporate earnings don't necessarily tell you what will happen in the stock market. As an investor, it's important to understand that there is no surefire strategy for investing because nothing always works. Investing is an ever-changing landscape and an investor's efforts to respond to the environment change it even further. Knowing this key mental model can help investors manage their expectations and make more informed decisions.
The Disconnect between the Stock Market and the Economy: The stock market operates independently from the economy and it's important for investors to not use economic news as a guide for market trends. Instead, they should rebalance portfolios regularly and understand that the market is a complex system influenced by patterns and intelligent agents.
The stock market and the economy are not synonymous, and bad news in the economy doesn't necessarily mean bad news for the stock market. Investors cannot use what's going on in the economy to inform what's going on in the stock market. The true value of a company is what the market says it is, meaning everyone else. The stock market operates similarly to a complex adaptive system with intelligent agents that learn from patterns. The GameStop scenario proves that the stock market can have real-world effects. It's important to note that even in a looming recession, investors shouldn't necessarily sell the stock market. Nobody can predict the bottom or the market's future movements, making it crucial to rebalance portfolios regularly.
Understanding the Complexity and Uncertainty of the Stock Market: The stock market is a complex and adaptive system where past patterns do not necessarily work in the future. Investors can learn from past crises and great investors’ approaches to navigate uncertain times.
The stock market is a complex and adaptive system where individual rational actions can lead to irrational outcomes system-wide, as seen in the toilet paper shortage during the pandemic. Attempts to model the stock market are difficult because patterns that have persisted in the past may not necessarily work in the future. The Great Financial Crisis was a crucial learning experience for investors to develop mental models and make good decisions. The economy and the stock market are not the same, and the stock market can rebound before the economy does. Learning from great investors and their approaches can help navigate uncertain times in the stock market.
The importance of diversification and being aware of 'invisible histories' in stock market predictions.: Don't rely solely on one person's opinion for stock market predictions. Diversify your investments and be aware of the potential outcomes that didn't happen when reflecting on past decisions.
Even experts with all the information and research can make wrong predictions about the stock market. It is important to not completely rely on one person's opinion or prediction and to keep a level head. This experience shows the importance of diversification, as the hedge fund that moved mostly to cash and gold missed out on the stock market's significant growth from March 9th, 2009 to the end of 2022. It is also important to be aware of 'invisible histories,' things that could have happened but didn't, when reflecting on past events and decisions.
Investing- More Luck than Skill: Relying on expert predictions or following our own predictions can be hazardous in investing. It is essential to remain well-diversified, have a long-term approach, take calculated risks, and keep emotions in check in investing.
Investing is more luck-based than skill-based, and following expert predictions or relying on our own predictions of the future can lead to costly mistakes. Michael Mauboussin's skill-luck continuum helps to determine where an activity falls on the spectrum of being skill-based or luck-based. Investing falls towards the luck end of the continuum, where skill matters but towards gambling. An amateur can beat a pro in investing, showing that it is not entirely a skill-based activity. Therefore, we should not invest solely based on predictions or expert opinions. It's crucial to have a well-diversified portfolio, a long-term outlook, and to take calculated risks while keeping emotions in check.
Investing in Stocks: Skill vs Luck and the Myth of Consistency: Investing in stocks is not a guarantee for success due to the role of luck and changing market conditions. Diversification, long-term investing, and avoiding reliance on past performance are essential for any investor.
Investing in stocks is not just about skill but also hugely dependent on luck. It is difficult to consistently pick stocks that will do well in the future. Even the best investment managers go through periods of underperformance, which can drive away investors. Moreover, the market conditions are continually changing, so success in one decade may not translate into success in the next one. Therefore, it is essential to not read too much into an investment manager's performance, whether good or bad, and to avoid making investment decisions based solely on past performance. Instead, investors should diversify their portfolio, consider low-cost index funds, and invest for the long term to reduce the impact of short-term market fluctuations.
The Impact of Investment Manager Strategy and Behavioral Biases on Returns: Choosing a long-term investment manager with a lockup period can increase returns, while awareness of behavioral biases such as overconfidence and loss aversion is crucial for making wise investment decisions.
Investment managers often change their strategy to avoid getting fired or to invest in a way similar to the market. The type of investment manager you choose impacts returns, and investing in a manager with a lockup period could increase returns over a long period by encouraging long-term investment decisions. Loss aversion and overconfidence are two common behavioral biases investors should be aware of, and they often work together. Overconfident investors tend to double down rather than lock in losses, which shows that they're being overconfident in their abilities. Being aware of these biases is important for making wise investment decisions, and it's human nature to succumb to them at times.
How Biases Impact Decision Making in Modern Times: Despite being hardwired into us, biases such as loss aversion and storytelling bias can be detrimental to investment decisions. Being aware of these biases can prevent poor investment choices.
Even with knowledge of biases, they are hardwired into us and difficult to overcome. These biases were evolved to aid in survival, but in modern times they can negatively impact decision making. Loss aversion, for example, served a purpose in a treacherous world, but now it doesn't make sense to give outsized focus and emotion to losses compared to gains in an abundant world. Additionally, storytelling bias is a lesser-known bias where people are drawn to a good story around an investment, which can lead to neglecting base rates. It's important to be aware of these biases to prevent being swayed into potentially poor investments.
The Importance of Stories in the Turing Test and Human Interaction: Stories play a crucial role in human interaction and intelligence evaluation. However, relying solely on stories can lead to overlooking base rates and probabilities. Understanding and researching base rates can help make better decisions.
The Turing test measures whether a computer can trick a human into thinking they are interacting with another human. One of the biggest challenges with AI passing this test is that humans interact through storytelling, and we judge each other's intelligence based on the quality and relevance of our stories. Humans evolved to be storytellers because it provided a survival advantage in working in larger groups. As a result, humans pay outsized attention to stories, which can lead to overlooking base rates or statistical probabilities. Understanding and researching base rates can help make more informed decisions, such as whether to FedEx a passport or wait for it to be delivered safely in person.
Overcoming the Storytelling Bias: Don't rely on stories or anecdotal evidence when making investment or medical decisions. Look at the base rate and research the facts before making informed choices. Being aware of storytelling bias can help you make better decisions.
As investors, we should be careful not to fall prey to storytelling bias, which makes us rely on anecdotal evidence or stories instead of considering the base rate or the likelihood of something happening in the real world. Companies and even fellow investors sell stories, which can easily sway our decisions. Therefore, we must pay attention to the base rate and research the actual facts before making an informed decision. The same applies to medical decision-making and other contexts. We should not let negative or positive stories attached to the choices we have sway us, but rather look at what the base rate tells us about the likelihood of success. Being aware of this bias can help us make better decisions.
Inflation and IPOs: How to Navigate Complex Investing Situations: Customize portfolios based on individual cash flow needs and risk tolerance, focus on disciplined rebalancing techniques for the long run, and approach IPOs with caution due to low success rates and potential incentives driving investment pitches.
Inflation is a complex phenomenon with no clear cause and effect relationship with asset classes. Even during high inflationary periods, equities have performed well in the long run. Customizing portfolios based on individual cash flow needs and risk tolerance is key, with a focus on rebalancing rather than trying to predict short-term market behavior. Investing in IPOs may have a good story, but base rates for their success are low, and investors should be cautious of incentives driving investment managers and companies to pitch them. John Jennings advises against trying to outguess asset allocations and instead advocates for disciplined rebalancing techniques and investing for the long term.
The Benefits of Static Asset Allocation and Humility in Investing: When investing, focus on long-term timeframes and recognize the role of buyer and seller behavior. Have a humble approach to investing and avoid trying to outguess the market. Overconfidence can be detrimental to portfolio performance.
Investors should focus on having a more static asset allocation and avoid trying to outguess the market. Other firms have tactical allocations that are right sometimes but wrong a lot, so it's better to have humility and realize that you're not going to be right all the time. Instead of worrying about short-term inflation and interest rates, it's better to focus on 20, 40, and 50 year timeframes. People tend to overestimate their knowledge and should have more humility and recognize the role that buyers and sellers play in the market. It's important to have a big healthy dose of humility and avoid taking overconfidence, which will hurt the portfolio more often than not.
