Filtering for Truth
In my role as a financial advisor I am often called upon by my clients to serve as a primary filter for financial information.
As one may expect, during times of financial uncertainty, there is a lot of sludge dredged up from the bottom of the barrel and it mixes in with a lot of flotsam that ought to have been skimmed off the top. The truth is thought to be somewhere in the middle, or is it?
Two opposing sides could passionately and eloquently argue their points about something and with much heated debate it may result in a draw. In that outcome, some would say the truth is somewhere in the middle. Such may not be the case. One or both sides may be wrong, despite the contentions and conviction in their message. The result of choosing one over the other, or going down the middle could have very interesting and unintended consequences.
If you’re looking for an example, there are many to choose from. We need look no further than the study of religion, the bailout of the auto and financial sectors, or the raising of the debt ceiling in the U.S. or Europe. The point is, there can be a lot of noise on either side of a stated position and we will seek and usually find the security of single fixed position.
One investment manager describes the search for truth as the information you know, information you know you don’t know, and information you don’t know that you don’t know. It’s the latter that can take the biggest toll on the unsuspecting. Some are smart enough to realize the limits of their circle of competence and they seek out others to collaborate with and trade for a collective benefit.
Most will attempt to avoid or mitigate the effects of mistakes by using diversification, or de-worsification as Buffett has referred to it. It’s taught from a young age not to put all our eggs in one basket and it’s reinforced in textbooks on investing and licensing exams all through the investing universe. Mutual funds are actually regulated to spread risk by strictly limiting concentration – no more than 10% in any one security. With investing, perfectly average equals returns that are slightly less than those of an index.
So how do we maintain clarity of thinking in a world of prolific thought sharing, and what do we have to do to avoid the creep of delusional thinking? It’s safe to say with an open mind, it’s amazing how much garbage others will want to put in there! The answer is we do our homework, so let’s look at what that means.
Charlie Munger in, Seeking Wisdom, poses the idea that we need to establish an intellectual framework for decision making. Within that framework there are a multitude of models which can be used to filter thoughts and ideas into a lattice work which support one another and lead toward the assembly of a single thesis. Malcolm Gladwell in his book, Blink, describes how this can happen very quickly, sometimes in the blink of an eye.
Munger outlines 70 or so different models which may be used to create this lattice work. To demonstrate the multi-disciplinarian approach, Munger cites examples from the disciplines of mathematics, engineering, chemistry, biology – as it concerns our genetic predisposition, and psychology particularly in the study of behavioral finance. For those that are interested, it makes for fascinating reading.
One thought in particular grips my thinking more than most others. “To the man with only a hammer, everything looks like a nail.” There are a number of really useful applications for this cautionary statement, so for the purpose of this message, let’s consider how an intellectual framework that is not fully constructed from a multi-disciplinarian approach may be left with obvious weakness.
It is true that 80% of the heavy lifting is often done by a small cross section of thought processes, along the lines of the Pareto Principle. The application of Murphy’s law – if something can go wrong, it will go wrong – can wreak havoc given only half a chance. Buffett once said something that could be considered a plug for the concept of over engineering, “Buy a business that a fool could run because someday it will be run by a fool.”
A little information can be dangerous. Superficial sound bites and 500 word page limits may not do full justice for getting at the truth. More and more today we find our attention spans shortened to a point where we rely entirely on others to do the thinking for us. Our system is oriented toward litigation driving more and more rules designed to protect those that are made vulnerable, in some cases by the mind numbing escalation of their own specialisation. With increased focus comes the loss of peripheral vision and the ability to think for ourselves.
In order to self-determine our future it becomes necessary to navigate through a gambit of promoters many of whom are cautiously avoiding agency risk, filtering the words that are spoken before we even have an opportunity to interpret the truth for ourselves. Efforts to save face and mask appearances behind fancy office towers and grandiose displays of wealth and stability are often displayed more aggressively than the actual transparency of truth.
If self-determination is at risk, it will not be routine markets cycles that bring about failure and mediocrity. It will have more to do with clarity of thinking and applying the right filters.