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Tuesday, 17 July 2012

Mindless Money 2/5: Don’t Oversimplify

Simplifying things is what we do, habitually.  The world is too complex, too multi-faceted for us to do anything else.  We develop a specific, individual mindset which we use to frame the world we operate in.  Sometimes this is a political viewpoint, sometimes it’s a tribal one, mostly it’s just the way we think about things.

Unfortunately oversimplifying stuff is a dangerous, mindless, trait for an investor.  You may think that the automobile or the internet is going to revolutionise business and you may even be right.  But that doesn’t mean that every company with “motors” or “.com” on the end is going to be a winner.

As each of us lives in a bubble of our own existence, with our own beliefs and preconceptions, and it’s very difficult for us to step outside of this and recognise the simplifications inherent in our mindsets.  We are, quite literally, framed by our brains.

Framing is the nasty behavioral bias that pre-disposes us towards certain behaviors.  We can be framed by clever manipulators who use priming to make us behave in ways that they desire, but all too often we’re the instigators of our own downfalls, by adopting so-called narrow frames, which limit our ability to analyse problems.

Narrow framing can come in all sorts of varieties. For instance, an adherence to a 1990’s style “buy and hold” mode of investing, while ignoring the broader history of market cycles, would be one such situation.  Another might be a belief that diversification always implies worse performance, without ever looking at the reasoning behind this.  Or you could believe that a business model developed in the 1920’s will work in the 2020’s without analysing why that might be.

One way of countering this problem, oversimplification, is to develop a wider range of views and experiences, exposing ourselves to a wider set of influences.  This is “liberal arts investing” – the idea that a good investor should reach avidly for learning from other spheres, to try and capture new metaphors that allow them to examine investing opportunities in different ways.

This metaphorical toolkit is Charlie Munger’s latticework of mental models, an overlapping and interacting set of ideas which can be used to probe and analyse investments in different ways.  The key, of course, is to select the right tools for the right situation – and that’s something that comes with experience, often hard-won.

Having multiple analytical perspectives on a problem will often generate a multiplicity of views.  Being able to integrate these views into a sensible outcome takes time and deep thought – but it’s a much more realistic view than can be generated by one, simplistic approach to investing.  Whether it’s a fundamental belief in index trackers, or value investing or social media based sentiment charting, there’s no one right way of doing this.  They’re all valid tools, and the more we can take from all of them, the better.

Accepting that life, and investing, isn’t simple is difficult.  But it makes both a lot more interesting, and a lot less mindless.

Further reading:

We looked at framing in Investors, You've Been Framed and looked at priming, one of the key ways in which we get framed by others in To Boldly Go: Risk and the Prime Directive.  The ability of investors to frame themselves during  dotcom mania was covered in The Halo Effect: What's In A Company Name? The particular meme associated with diversification was discussed in Diworsification Is Good For You and we examined the general issue of memetic reproduction in financial markets in Memes, Money, Madness. Munger's great idea of liberal arts investing, is discussed in Mental Models, Arrayed On Charlie Munger's Latticework.

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Next >> Mindless Money 3/5: Hold the Big Picture

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