The great modern philosopher of our age, Pogo, describes the nature of the failure of the human condition by intoning, “I have met the enemy, and the enemy is us.” In essence, what he is saying is that, individually and collectively, we cause our own problems. How can this be? Aren’t we the most brilliant people with the best education and the greatest media support the world has ever seen? And we seem to make the same mistakes as our ancient ancestors. I would suggest that the primary reason for our failure to develop a higher percentage of winning bets is that we have limited our learning capacity.
Our first fundamental mistake, as mentioned in last week’s blog, is a lack of full understanding of Newton’s Third Law of Motion, that every action creates an and equal and opposite reaction: You kill me, my son or brother will kill you, etc. As a “certified bright person,” I may perceive buying something as cheap, while the seller, equally bright and perhaps with more or different information considers the sale as off-loading an expensive piece of merchandise. If a government restricts a profitable trade for someone, a willing buyer and seller will find other ways to transact, even if trading costs are higher.
Our second mistake is where we look for guidance and how we receive it. Consider if you were going to have a critical medical operation, or have a major piece of architecture begun, you probably would search for the most knowledgeable expert that was available. In our selection process, experience usually plays a major role. In contrast, I would look for an expert who had some failures (e.g. a patient died, or a building did not meet with its essential critical requirements). Personally, I would have little confidence in an all-knowing arrogant personality, who would be unlikely to quickly identify when something was going wrong and thus less prepared to shift course.
In contrast to the somewhat painful experience searching for medical or architectural experts, when seeking financial advice we rely on 20 second sound bites, 55 minute university lectures and newspaper columns limited to 700 words or less from very thoughtful columnists such as Jason Zweig, in the weekend Wall Street Journal.
As all of us are insecure about making financial and investment decisions, we tend to find comfort in conforming to what other individuals of perceived similar intelligence do with their money. (The prudent man principle is based on this conformity, not on what was actually prudent under the circumstances.) Our decision-making may be compared to a voting machine or a set of scales. Most often the quantity of popular views weighs more heavily in our decisions than the apparent expertise of one or more experienced leaders.
To overcome this quantity over quality trap in building portfolios of funds for wealthy families or institutions, I try to select a few managers who see the market and the world differently than the rest. To me, the greater the arrogance, the greater there is the need to hedge and find different smart views. One way I try to reduce the power of the enemies is to control my own arrogance.