This article is the seventh of this weekly series called Latticework of Mental Models, which will be authored by my friend and partner in writing the Value Investing Almanack, Anshul Khare. Anshul will write on various mental models – big ideas from various disciplines – which can help you think more rationally while analyzing businesses and making your stock investment decisions.
What’s your favourite day or time of the week? For somebody like me with a Monday-Friday job, the favourite part of the week usually is Saturday morning.
Now, what could be the best way to ruin a Saturday morning? Let me tell how I (almost) achieved the feat.
On a cool and breezy weekend morning when most people prefer to sit in the balcony and sip on a hot beverage, I was standing just outside my front door with milk packet in hand and toothbrush in my mouth, wondering why do they build these auto-lock doors.
Yes, you guessed it right. I managed to lock myself out of my house. Everything including my keys, glasses, cell phone, wallet, and slippers were behind the door which was slammed shut by the very same saturday morning breeze.
However the story had a happy ending when I was rescued by my saviour. Saviour? Yes and it was none other than our mental model for today – Mr. Red (short for Redundancy).
Fortunately I had kept a spare key with my trustworthy friend living few blocks away. I quickly ran to his house, got my spare key and thanked Mr. Red.
Although it did raise few eyebrows among the neighbours when they saw a guy with disheveled hair, scurrying across the street barefoot with a milk packet in hand and toothbrush sticking out from mouth. Forgive me for being little too dramatic here but please stay with this post for a little longer to know more about the insightful personality of Mr. Red.
I know that sharing a spare key isn’t a novel idea. People do it all the time but it highlights the significance of building redundancy in our day to day affairs. If redundancy is so important in such small matters, imagine its utility in other critical matters. That’s what we are going to explore today. So let’s start with a working definition.
Redundancy is defined as the existence of more than one means for accomplishing a given task. To be more specific, redundancy refers to the process of adding ‘extra’ instances of critical components to a system so that one can take over for another if something breaks. Thus all of these ‘instances’ must fail before there is a system failure.
Look around you. Spare tyre in your vehicle, power backup generator sets in your apartment, fire exits in your office building, etc., are all typical examples of redundancy designs.
To an untrained eye, redundancy may seem ambiguous because it looks like a waste of resources if nothing unusual happens. Except that the complexity of modern world ensures that the unusual would happen quite frequently and unexpectedly.
Have you ever keenly observed the nature? It’s the best place to learn about redundancy.
Redundancy in Nature
If you look at the mother nature it’s easy to see that redundancy is everywhere. Nassim Taleb writes in Fooled by Randomness –
Mother Nature likes redundancies…the simplest to understand, is defensive redundancy, the insurance type of redundancy that allows you to survive under adversity, thanks to the availability of spare parts. Look at the human body. We have two eyes, two lungs, two kidneys, even two brains – and each has more capacity than needed in ordinary circumstances.
So redundancy equals insurance, and the apparent inefficiencies are associated with the costs of maintaining these spare parts and the energy needed to keep them around in spite of their idleness….Layers of redundancy are the central risk management property of natural systems.
A lot of species in animal kingdom give birth to multiple offsprings (it’s common for some insects and fishes to lay millions of eggs in a single season) to ensure that at least some of them survive and carry forward the gene. Isn’t that redundancy? Nature likes to over-insure itself.
As an aside to the central argument of redundancy, it’s worth mentioning an interesting insight which comes from Bill Gates. One of the focus areas for his philanthropic initiatives is to improve the child survival rates in poor African countries. For many naive armchair philosophers, it seems counter intuitive because logic says that instead of focusing on saving newborns, we should educate the poor women to have fewer kids since it’s common in these countries for families to have 3-4 children. Moreover saving children will eventually lead to a bigger population in future which in turn will worsen the living conditions further. Right? Wrong!
Look at this situation from the lens of redundancy mental model. One of the reasons people (and this could be a subconscious drive instilled by nature) have multiple children is – they assume some of those children aren’t going to survive to adulthood because of poor health care facilities. However Mr. Gates’ argument is that the moment you improve the survival rate for children, people won’t feel the need to have multiple children. So, over the long term, you end up eliminating the root cause of population growth. It’s a brilliant insight.
Let’s now shift gears a bit and turn to the field of engineering.
Redundancy in Engineering
We saw redundancy in nature is quite common but this mental model can be formally categorised as a big idea from the field of Engineering.
In fact, when it comes to software engineering, building backup and additional redundant capacity is at the heart of architecting software systems. Large software enterprises (including Facebook, Google, Twitter, and all the banks) go as far as having multiple data centers spread across continents to ensure that even large scale catastrophic events don’t cause irrecoverable damage.
Most of the commercial airliners have multiple engines so in case of failure of even a single engine, the flight can continue with spare engines. And not just the engine, most of the critical parts in an airplane have redundancy of some form or other.
In fact, while designing critical systems, it doesn’t suffice to build redundancy based on the historical worst case scenario. You actually have to overcompensate. Because the so-called worst-case event, when it happened, exceeded the worst case at that time. Nassim Taleb has named this inconsistency as “The Lucretius Problem”.
Redundancy in Investing
The great Chinese philosopher Confucius said –
The superior man, when resting in safety, does not forget that danger may come. When in a state of security he does not forget the possibility of ruin. When all is orderly, he does not forget that disorder may come. Thus his person is not endangered, and his States and all their clans are preserved.
One of first things advised for personal finance is to create an emergency fund for yourself. This fund should cover 6 to 8 months of your expenses and it should be kept ultra safe i.e., either in FDs or liquid funds. That’s creating redundancy for securing the future of your family. Getting adequate medical and life cover adds additional redundancy.
The father of value investing, Benjamin Graham, pioneered the concept of margin of safety which is nothing but building redundancy in your investment portfolio. Warren Buffett, in his 1993 letter to investors, says –
We insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we’re not interested in buying. We believe this margin-of-safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success.
In fact, having redundant cash in your investment kitty isn’t merely a defensive strategy. Come a market crash and your defensive strategy opportunistically turns into an aggressive strategy. It’s more like an investment rather than insurance.
For that matter, debt is the inverse of redundancy. It not only takes away the safety, it actually makes your finances extremely fragile in the face of unexpected adversity.
Where It Fails
Before we become too obsessed with the idea of redundancy, it’s important to understand its limitations, lest we become the proverbial man with the hammer to whom every problem looked like a nail.
Can redundancy backfire? Shane Parrish, in his blog Farnam Street, explains it wonderfully –
First, in certain cases, the added benefits of redundancy are outweighed by the risks of added complexity. Since adding redundancy increases the complexity of a system, efforts to increase reliability and safety through redundant systems may backfire and inadvertently make systems more susceptible to failure. An example of how adding complexity to a system can increase the odds of failure can be found in the near-meltdown of the Femi reactor in 1996. This incident was caused by an emergency safety device which broke off and blocked a pipe stopping the flow of coolants into the reactor core. Luckily this was before the plant was active.
Second, redundancy with people can lead to social diffusion where people always assume it was someone else who had the responsibility.
Another way in which redundancy can cause damage is when it makes people overconfident. How?
You must have heard this joke floating around on the Internet – You don’t need a parachute for skydiving. You need it for trying skydiving more than once. 🙂
Every skydiver jumps with a reserve parachute. What if even the second doesn’t open up? Well…so much for skydiving! Irony is that presence of a backup promotes the skydivers to attempt even riskier maneuvers which defeats the purpose of having additional safety.
Similarly, as the automobiles become safer, drivers go faster and take on more risks. Same in case of sports too. The recent tragic demise of an Australian cricketer Phil Hughes can probably be attributed to the same reason.
Facing express bowlers of the past, whether Harold Larwood, Andy Roberts or Malcolm Marshall, helmet-less batsmen were less inclined to play the hook—a shot that involves swatting a short-pitched ball from in front of your nose—because of the danger of getting it wrong. They were also more likely to keep their eye on a threatening ball and sway out of the way at the last moment, as the coaching manual demands. Today, with greater protection, there seems to be more of a propensity for batsmen to flinch and turn their backs on anything nasty… those with exposed heads were more likely to play back-foot shots, which give batsmen extra time to follow the flight of the ball. (source: Economist)
So do you see the paradox of redundancy?
Nonetheless it’s an important mental model and extremely useful one in designing systems around us.
If you thought that after that fateful Saturday morning, I would have learnt my lesson, then you are underestimating me. I repeated the same blunder but this time with my car and as usual Mr. Red saved me again.
I guess it should be obvious to you by now that creating redundancy doesn’t mean avoiding the worst case scenario, but it assumes that the worst case will happen time to time and then making arrangements to minimize the harm.
So please don’t forget to make friends with Mr. Red.
Now that we have learned some mental models in past few weeks, the next questions is what to do with them? Shane of Farnam Street again answers this question beautifully –
After we learn a model we have to make it useful. We have to integrate it into our existing knowledge. Our world is multidimensional and our problems are complicated. Most problems cannot be solved using one model alone. The more models we have the better able we are to rationally solve problems. But if we don’t have the models we become the proverbial man with a hammer. To the man with a hammer everything looks like a nail. If you only have one model you will fit whatever problem you face to the model you have. If you have more than one model, however, you can look at the problem from a variety of perspectives and increase the odds you come to a better solution.
As always I would urge you to become a proactive learner. Reading educates, but when you put your own independent thinking to what you learn, it makes the lesson last longer. So I invite you to take a pause for few minutes and think about your own experiences and observations where these mental models might fit in.
If you can share them in Comments section of this post, others (including me) would benefit from your thinking and of course just the act of writing will unleash interesting insights in your own head.
So what are you waiting for? Lose the mouse, grab the keyboard and start typing.
It is my sincere hope that the latticework series will enrich your world by making it a more profitable and enjoyable place to invest, work, and live.
Take care and keep learning.