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Archives for September 2015

Latticework of Mental Models: Framing Effect

“Is it okay to smoke a cigarette while praying to God?” a young man asked his father, a religious man.

“Of course it’s bad. It’s a great sin and very disrespectful act,” the father replied. He was disturbed with his son’s atrocious question.

“But last time you told me that to get rid of my addiction I should start praying while smoking. Didn’t you say that?” It seemed to him that his father was contradicting himself.

“No my son! Don’t confuse smoking-while-praying with praying-while-smoking,” the father explained.

“But what’s the difference?” the son was perplexed.

“There is a difference. A huge difference. I don’t know what but my brain tells me that there is.”

Now before we get started on a debate about the validity of father’s argument, let me clarify that the reason I brought up this anecdote was to highlight an important mental bias which plays out in our affairs very subtly.

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Hope Is Not An Investing Strategy

“I hope the stock market rises again,” my friend Ravi told me as we met for dinner during the weekend.

“Why?” I asked.

“I have put in a lot of money over the last few months…that’s why!” he replied.

“Ravi, it’s good to be an optimist by nature,” I said, “But ironically, it doesn’t work that way in the stock market.”

“Why do you say so Vishal? Isn’t it a basic human nature to hope for the best?”

“Of course yes. In fact, I believe that hope is a component of a healthy state of mind, and opposite of negativity that we see all around. But then, when it comes to the stock market, hope is dangerous.”

“But why?”

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Why Good People Do Bad Things: A Conversation With My Daughter

Volkswagen, the world’s third largest in terms of vehicle sales, recently admitted to cheating on emissions data for 11 million of its diesel engine cars sold between 2009 and 2015.

As I was explaining the scandal to my daughter, the first question she asked was – “Why do they do such wrong things, Papa? Aren’t they already rich?”

“Good question Kavya,” I said. “It’s especially good to know that you understand what they did i.e., cheat their customers, was wrong.”

“But they are good people, right Papa?” she asked.

“Yes the people who created the scandal must have come from good families,” I replied, “…and must have been good with their family and friends.”

“So why good people do bad things?” she asked again, this time combining all her questions into one.

“Let me tell you a story, Kavya,” I said, “…story of a young girl named Barbie.”

“Wow, Barbie is my favorite doll,” she exclaimed with a smile.

“Yeah, but for the time being, let’s forget that she is a doll and let’s focus on the story.”

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Latticework of Mental Models: Pavlovian Conditioning

Last month I decided to pay a visit to my friend Dr. Placebo in his clinic. It was a Friday and for some strange reason people are too happy to fall sick on a Friday. So it was a relatively less busy day for my doctor friend. For that matter it should be easy for you to guess the busiest day of the week for him – Monday of course. 🙂

I wasn’t sick as such but I like to catch up with Dr. Placebo once in awhile. In the past he has helped me in thinking about important mental models including Do Something Bias [1] and Mean Reversion [2]. So I was hoping that a chit chat with him will again nudge me to some fresh insights. I wasn’t wrong.

“So doc! Tell me something ironical about your profession?”, I asked him thinking that a question like that could lead the conversation to an interesting direction.

“The biggest irony of being a physician is that many people don’t really need doctor’s help. Many a times, my prescription is effective because people believe in them. Their belief in my treatment is what cures them. You see your doctor and you feel better.”

He continued, “Sometimes just the fact that a doctor or nurse is paying attention to us and reassuring us not only makes us feel better but also triggers our internal healing processes. In many cases they would benefit just by popping a sugar pill. And it’s a proven fact also known as Placebo Effect.

“I see. That kind of explains your strange name.”, I winked thinking that he wouldn’t mind a friendly tease.

“Don’t get me started on the origins of my name. But you should read about Pavlovian Conditioning. Now if you please excuse me, I have to leave now. It’s Friday and I have plans.”, saying this he got up from his chair and started leaving.

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My Interview with Terrible Mr. X – Lessons on What NOT To Do in Stock Market

Disclaimer: This article is a piece of satire, a figment of my imagination. But it is still an expression of what I see in the real-life stock market and how most people behave when it comes to investing their hard-earned money. Any resemblance to any living person is purely coincidental, though I would love to meet that person and interview him.

Today is January 1, 2045…so happy new year, tribe members. I hope you had a great start to the year, and hope that you manage to take your resolution(s) past the first 30 days of January.

Anyways, I recently got a chance to interview one Mr. X (not his real name), who has been in the stock market for the past 35+ years – starting 2007 – but has NOT been able to create wealth over such a long time. In fact, net-net, he has been a loser after more than three decades of playing the stock market. And he continues to play it, as he believes that there’s no easier way of making quick money.

I love the patience and perseverance that he has shown all these years in losing money and never learning from his mistakes. And that’s why I thought he was a great interview material. Why?

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5 Things I Learned from Elon Musk on Life, Business and Investing

Here’s a simple question someone asked on Quora – Will I become a billionaire if I am determined to be one and put in the necessary work required?

Here’s how a lady answered this –

No.

One of the many qualities that separate self-made billionaires from the rest of us is their ability to ask the right questions.

This is not the right question.

(Which is not to say it’s a bad question. It just won’t get that deep part of your mind working to help you — mulling things over when you think you’re thinking about something else — sending up flares of insight.)

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A Crash Course in Building Your Latticework of Mental Models

Note: This is a review of Robert Hagstrom’s book Latticework – The New Investing [1]. This review first appeared in February 2015 issue of our premium newsletter, Value Investing Almanack.

As a school kid, when I was taught to solve a mathematical problem in a certain way, nobody encouraged me further to attempt the same problem in another way. You know why? Because in our traditional education system we have been trained to think in a limited way.

Charlie Munger, the inimitable vice chairman of Berkshire Hathaway, calls this a-man-with-a-hammer syndrome – To a man with hammer, every problem looks like a nail. So how do you overcome this handicap? The answer lies in developing a sound thinking process and that’s where multidisciplinary learning comes into picture.

latticeworkHagstrom’s book, unlike most other investment books, is about Munger’s way of learning – multidisciplinary education. So I won’t advise you to read this book if all you are looking for is magic formulas or readymade rules of sound investing.

This is a powerful book arguing for the importance of a multidisciplinary approach to investing. So if you are one amongst the many investors who have been searching out companies to invest in for a number of years and all you have learned is to plug basic financial information into excel models, this book will give you some new mental tools to assist your analysis.

The term latticework is attributed to Charlie Munger. He views a latticework of mental models [2] as an interlocking structure of ideas that is clearly multidisciplinary in nature. Drawing from this transdisciplinary focus, Hagstrom takes us through some key principles or laws from a number of disciplines such as psychology, physics, biology, and philosophy, among others. He then applies these theories to investing and the stock market.

Hagstrom argues that a successful stock picker must be ready to shift models and look at the markets from different vantage points with the passage of time. Instead of working like an analyst – using just factual information to plug into excel models – investors need to regard the insights or models from other disciplines too.

The task of the investor, Hagstrom explains, is to be well-read and always be on lookout for new perspective of understanding the world around us.

Anyways, before talking about this book, let me share with you a quote from Charlie Munger –

You must know the big ideas in the big disciplines, and use them routinely…if the facts don’t hang together on a latticework of theory, you don’t have them in a usable form. You’ve got to have models in your head. And you’ve got to array your experience – both vicarious and direct – on this latticework of models.

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Latticework of Mental Models: Inversion

Watch this one minute video [1] and when you’re done smiling, think about the problem in a rational way.

At first, the problem seemed that the kid had his head stuck between the iron bars. Although nobody saw how the kid’s head really got trapped in the first place – they just assumed that he somehow managed to slide his head through the narrow bars. Naturally, the intuitive solution was to pull the head in the same way it got stuck – which obviously didn’t seem to work.

But the right solution appeared when people stood the problem on its head (no pun intended) i.e., instead of trying to pull the head they pushed in the body through the trap. They inverted the problem and voila! Problem solved.

That’s called principle of inversion. It’s a common trick used by mathematicians but rarely practiced outside the discipline of mathematics. Carl Jacobi, a German mathematician, said, “Invert, always invert”, expressing his belief that the solution of many hard problems can be clarified by re-expressing them in inverse form.

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