It’s a human tendency to address a complex problem with a complex solution. And when it doesn’t work, man starts looking for an even more complex solution.
In an uncertain world, seeking complexity is a big error. Complex problems do not always require complex solutions. Overly complicated systems like financial markets are not only difficult to comprehend but easy to exploit and possibly dangerous.
In investing, less is more.
Warren Buffett, in his 2004 letter to shareholders, wrote…
Last year MidAmerican wrote off a major investment in a zinc recovery project that was initiated in 1998 and became operational in 2002. Large quantities of zinc are present in the brine produced by our California geothermal operations, and we believed we could profitably extract the metal. For many months, it appeared that commercially-viable recoveries were imminent. But in mining, just as in oil exploration, prospects have a way of “teasing” their developers, and every time one problem was solved, another popped up. In September, we threw in the towel.
Our failure here illustrates the importance of a guideline – stay with simple propositions – that we usually apply in investments as well as operations. If only one variable is key to a decision, and the variable has a 90% chance of going your way, the chance for a successful outcome is obviously 90%. But if ten independent variables need to break favorably for a successful result, and each has a 90% probability of success, the likelihood of having a winner is only 35%. In our zinc venture, we solved most of the problems. But one proved intractable, and that was one too many. Since a chain is no stronger than its weakest link, it makes sense to look for—if you’ll excuse an oxymoron—mono-linked chains.
Occam’s Razor is the mental model which captures this idea of staying with simple propositions. It states that among competing hypotheses, the hypothesis with the fewest assumptions should be selected.
So here’s the second episode of our Latticework of Mental Models Video series, explaining Occam’s Razor. We hope this video illustration makes this idea stick better in your memory.
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If you wish to read more on Occam’s Razor click here.
Take care and keep learning.