Quotes...

Below are some quotes that I thought were good ones on which to end 2013 and keep in mind as we enter 2014.

From Ray Dalio:

The biggest mistake investors make is to believe that what happened in the recent past is likely to persist.

From Howard Marks:

If you buy a cheap stock when the market is high, it is a challenge because, if the market being high is followed by a general decline in prices, then for you to make money in your cheap stock, you have to swim against the tide. If you buy when the market is low, and that lowness is going to be corrected by a general inflation, and you buy your cheap stock, then you have the tailwind in your favor….I think it is unrealistic and maybe hubristic to say, “I don’t care about what is going on in the world. I know a cheap stock when I see one.” If you don’t follow the pendulum and understand the cycle, then that implies that you always invest as much money as aggressively. That doesn’t make any sense to me. I have been around too long to think that a good investment is always equally good all the time regardless of the climate.

From Seth Klarman:

Accepting that we cannot predict the future--i.e., that there will always be unexpected and highly consequential events--is the first step in becoming less fragile and more adaptable. People should be highly skeptical of anyone’s, including their own, ability to predict the future, and instead pursue strategies that can survive whatever may occur. Taleb advises us to be “antifragile”-- i.e., to embrace those elements that benefit from volatility, variability, stress, and disorder. This is exactly what we strive to do at Baupost, and Taleb has coined a name for it. The world will always deliver surprises coming from left field, things that have never happened before or, at least, that no one can remember having happened. As Nobel Laureate Daniel Kahneman notes, people tend to underestimate the odds of extreme events that haven’t occurred recently. It’s a tendency known as availability bias. This tendency is crucial to effectively position ourselves to survive and even thrive regardless of an uncertain future. How do we do that? By eschewing portfolio leverage, keeping ample cash balances ready for rapid deployment, pursuing a mostly generalist and flexible approach while avoiding narrow silos, seeking bargain-priced investments where possible adverse developments are already priced in, holding numerous investments with uncorrelated catalysts to drive outcomes irrespective of market levels, maintaining prudent diversification, demanding high intellectual honesty while consistently striving to improve, and having clients whose long-term orientation matches our own. 

In the financial markets, there is rarely anything new under the sun, but you can never say you’ve seen it all, and what you thought you would never see can clobber you. 

We make no heroic assumptions in our analysis, hoping, instead, that by compounding multiple conservative assumptions, we will create such a substantial margin of safety that a lot can go wrong without impairing our capital much or even at all. We never invest just to invest and don’t bet blindly on mean reversion or on historical relationships holding up. Our settings are permanently turned to “risk off.”

Chart of the day: Margin Expansion

Link to Source

Article that accompanied the chart from Advisor Perspectives via Leuthold Weeden:

Investors routinely attribute today’s near-record margins to operating efficiencies like factory automation and the outsourcing of labor to lower-wage foreign locales. This is certainly an attractive story, but the reality is that competition demands these actions, and many more, to merely maintain margins. 

We don’t understand why economists who seem to be perfectly good capitalists in every other way think these innovations should result in a permanent jump in profitability.

For the third quarter, the National Income and Product Account (NIPA)—a broad measure of profitability that includes both public and private companies—came in at 10.1% of GDP, ticking up from a revised 10.0% in the second quarter. The all-time record of 10.3% was established in the fourth quarter of 2011. 

The table is clear: the margin expansion story of the last 20 years is a financial one, not an operating one. Net profit margins have increased to 10.1% in the latest quarter from a technology-boom peak of 7.3% in the third quarter of 1997. 

But operating (or “EBIT”) margins have barely budged since that 1990’s peak—up only 20 basis points. The key developments have been the continuing shrinkage of interest expense and (secondarily) the corporate income tax burden; relative declines in these two items account for 2.6% of the 2.8% jump in net profit margins since 1997. Boring, but true. 

What’s clear is that the predominant effect—the drop in interest expense—has almost certainly fully run its course. What will move margins next? Some might say 3-D printing, or even drone deliveries from Amazon. Our best guess? Gravity.

CONTRARIAN - a documentary about John Templeton

Found via ValueWalk.

Directed by award-winning filmmaker Mary Mazzio, CONTRARIAN chronicles the life and legacy of legendary investor John Templeton. Underwritten by the John Templeton Foundation.


Link

Richard Duncan's interview on The McAlvany Weekly Commentary

Link to MP3: Richard Duncan on The McAlvany Weekly Commentary

Howard Marks' LSE Lecture

Found via ValueWalk.


Link

Richard Dawkins and Brian Greene in Conversation at 92Y

Link

Richard Fisher on EconTalk

Richard Fisher, President of the Federal Reserve Bank of Dallas, talks with EconTalk host Russ Roberts about the problems with "too big to fail"--the policy idea that certain financial institutions are too large to face the bankruptcy or failure and need to be rescued or bailed-out. Fisher argues that "too big to fail" remains a serious problem despite claims that recent financial regulation has eliminated it. Fisher discusses various ways to deal with too-big-to-fail, including his own preferred policy. The last part of the conversation deals with quantitative easing and monetary policy during the crisis.

The Best Financial Advice I Ever Got (or Gave): Wisdom from 22 successful investors

The holidays are a time for relaxing, helping the less fortunate, showering family and friends with love and attention—and, sometimes, for smiling and nodding through unsolicited stock tips from an overbearing relative who has been sampling the eggnog.

But good advice can make careers and forever change lives for the better. So The Wall Street Journal asked an array of prominent people who manage, invest, study and write about money to share the single best piece of financial advice they ever received—or gave.

The respondents included investors who collectively have earned billions of dollars for clients and themselves; founders and owners of businesses that are household names; and Nobel laureates who shaped the world's understanding of the forces that drive the stock market.

A leading federal judge who has presided over cases related to the financial crisis shared his thoughts, as did an agent who has negotiated some of the most lucrative contracts in the history of sports and an adviser who helps clients recover financially after a divorce.

In most cases, the recommendations are easy to follow today. Some reflect conventional wisdom, while some fly in its face. Not every tidbit is consistent with all the others. The responses, some of which were edited for clarity, appear below.

But first, a word of caution: Like all advice, it should be weighed soberly—ideally, at a good distance from the eggnog.

…..

Seth Klarman, president of the Baupost Group, a Boston-based hedge fund

Wally Carucci [of brokerage firm Carr Securities], a dear friend who passed away this last year, was an amazing mentor to me 30 years ago. The wisdom he gave to me was "You have to feed the birdies when they're hungry."

There are two ways to interpret that. There's the superficial meaning: Don't forget to sell, and always remember that it's easier to buy than to sell. But what he was really talking about is that liquidity is ephemeral. Wally was best known for his research on very illiquid, thinly traded stocks. What he meant on the deeper level is that when people want to take you out of an asset for a full price, don't hold out for the last dollar.

Metaphors Are Us – By Robert Sapolsky

Thanks to Kjetil for passing this along.

Humans used to be unique in lots of ways. We were the only species who made tools, murdered each other, passed on culture. And each of those supposed defining features has now been demonstrated in other species. We’re not so special after all. But there are still ways that humans appear to stand alone. One of those is hugely important: the human capacity to think symbolically. Metaphors, similes, parables, figures of speech—they exert enormous power over us. We kill for symbols, die for them. Yet symbols generate one of the most magnificent human inventions: art.

In recent years scientists from leading universities, including UCLA, University College London, and Yale, have made remarkable insights into the neurobiology of symbols. A major finding from their work is that the brain is not very good at distinguishing between the metaphorical and literal. In fact, as scientists have shown us, symbols and metaphors, and the morality they engender, are the product of clunky processes in our brains.

Hussman Weekly Market Comment: Estimating the Risk of a Market Crash

“We thought it was the eighth inning, and it was the ninth. I did not think it would go down 33 percent in 15 days.”

In April 2000, Stanley Druckenmiller, who managed the phenomenally successful Quantum fund for George Soros, called it quits – saying “I overplayed my hand” in technology stocks. The Nasdaq composite had suffered the first blow of what was to become a much deeper loss, with the index losing an additional 70% by 2002 low. Still, getting out was a good idea in hindsight.

With one of the best records in the industry, Druckenmiller has expressed increasing concerns recently that “all the lobsters are in the pot.” A few weeks ago, he said of equities that he holds “the smallest positions I’ve had,” and warned “a necessary condition for a financial crisis, in my opinion, is too loose monetary policy that encourages people to take undue risk.”

Floyd Norris of the New York Times reported in 2000 that Druckenmiller was actually the second high-profile hedge manager to call it quits in that cycle. The first was Tiger Fund’s Julian Robertson, who had lagged the advance because he (correctly, in hindsight) viewed technology stocks as vastly overvalued. The article quoted an analyst saying “The moral of the story is that irrational markets can kill you. Julian said ‘This is irrational and I won’t play,’ and they carried him out feet first. Druckenmiller said ‘This is irrational and I will play,’ and they carried him out feet first.”

As I noted a few weeks ago “The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak. There’s no calling the top, and most of the signals that have been most historically useful for that purpose have been blazing red since late-2011.” My impression remains that the downside risks for the market have been deferred, not eliminated, and that they will be worse for the wait.

TED Talk - Apollo Robbins: The art of misdirection

Link

Complexity economics: a different framework for economic thought - by W. Brian Arthur

Abstract

This paper provides a logical framework for complexity economics. Complexity economics builds from the proposition that the economy is not necessarily in equilibrium: economic agents (firms, consumers, investors) constantly change their actions and strategies in response to the outcome they mutually create. This further changes the outcome, which requires them to adjust afresh. Agents thus live in a world where their beliefs and strategies are constantly being “tested” for survival within an outcome or “ecology” these beliefs and strategies together create. Economics has largely avoided this nonequilibrium view in the past, but if we allow it, we see patterns or phenomena not visible to equilibrium analysis. These emerge probabilistically, last for some time and dissipate, and they correspond to complex structures in other fields. We also see the economy not as something given and existing but forming from a constantly developing set of technological innovations, institutions, and arrangements that draw forth further innovations, institutions and arrangements. 

Complexity economics sees the economy as in motion, perpetually “computing” itself—perpetually constructing itself anew. Where equilibrium economics emphasizes order, determinacy, deduction, and stasis, complexity economics emphasizes contingency, indeterminacy, sense-making, and openness to change. In this framework time, in the sense of real historical time, becomes important, and a solution is no longer necessarily a set of mathematical conditions but a pattern, a set of emergent phenomena, a set of changes that may induce further changes, a set of existing entities creating novel entities. Equilibrium economics is a special case of nonequilibrium and hence complexity economics, therefore complexity economics is economics done in a more general way. It shows us an economy perpetually inventing itself, creating novel structures and possibilities for exploitation, and perpetually open to response.

Grant's Winter Break 2013 issue

This compilation of recent articles, our annual Grant’s Holiday e-issue, is for you—and for your friends, co-workers, clients, classmates, shipmates, brothers-in-law and maids-of-honor, too. Please pass it along, with our compliments, to any and all prospective members of the greater Grant’s family.

Charlie Munger quote

Via my 2009 interview with Peter Bevelin:

“We use a lot of experience and do it [investment returns] in our heads. We don’t like complexity and we distrust other systems and think it many times leads to false confidence. The harder you work, the more confidence you get. But you may be working hard on something that is false. We’re so afraid of that process so we don’t do it.”

Seneca quotes

"...human nature is so constituted that insults sink deeper than kindnesses; the remembrance of the latter soon passes away, while that of the former is treasured in the memory..."

"The man who while he gives thinks of what he will get in return, deserves to be deceived."

"It is the property of a great and good mind to covet, not the fruit of good deeds, but good deeds themselves, and to seek for a good man even after having met with bad men."

"The book-keeping of benefits is simple: it is all expenditure; if any one returns it, that is clear gain; if he does not return it, it is not lost, I gave it for the sake of giving."

"The things which we hold in our hands, which we see with our eyes, and which our avarice hugs, are transitory, they may be taken from us by ill luck or by violence; but a kindness lasts even after the loss of that by means of which it was bestowed; for it is a good deed, which no violence can undo."

Source

Some of Nassim Taleb's Facebook quotes

The danger of reading financial & other news (or econobullshit) is that things that don't make sense at all start making sense to you after progressive immersion. 

It's a sign of weakness to worry about showing signs of weakness. 

Friends, I wonder if someone has computed how much would be saved if we shut down economics and political science departments in universities. Those who need to research these subjects can do so on their private time. 

I trust those who trust me and distrust those who are suspicious of others.
A good man is warm and respectful towards the waiter or people of lower rank. 

Journalists feel contempt for those who fear them and a deep resentment for those who don't. 

When someone starts a sentence with the first half containing "I", "not", and "but", the "not" should be removed and the "but" replaced with "therefore.” 

Scott Adams quotes

I'm listening to How to Fail at Almost Everything and Still Win Big: Kind of the Story of My Life in my car and am really enjoying it. I found some quotes from the book via Derek Sivers and thought I'd share a few below. There are many more HERE.

Failure always brings something valuable with it. I don’t let it leave until I extract that value. 

Never make a loan to someone who is following his passion. He’s in business for the wrong reason. The best loan customer is one who has no passion whatsoever, just a desire to work hard at something that looks good on a spreadsheet.

It’s easy to be passionate about things that are working out, but they drain your passion as they fail. 

In hindsight, it looks as if the projects I was most passionate about were also the ones that worked. But objectively, my passion level moved with my success. Success caused passion more than passion caused success.

Have a system instead of a goal. Systems-driven people have found a way to look at the familiar in new and more useful ways. 

Running a marathon in under four hours is a goal, but exercising daily is a system.

A system is something you do on a regular basis that increases your odds of happiness in the long run. If you do something every day, it’s a system. If you’re waiting to achieve it someday in the future, it’s a goal.

Buying lottery tickets is not a system no matter how regularly you do it. 

The world offers so many alternatives that you need a quick filter to eliminate some options and pay attention to others. Whatever your plan, focus is always important.

If you want success, figure out the price, then pay it. It sounds trivial and obvious, but if you unpack the idea it has extraordinary power. 

Success has a price, but the price is negotiable. If you pick the right system, the price will be a lot nearer what you’re willing to pay.

If you learn to appreciate the power of systems over goals, it might lower the price of success just enough to make it worth a go.

A good conscience is a continual Christmas...

“Let no pleasure tempt thee, no profit allure thee, no ambition corrupt thee, no example sway thee, no persuasion move thee, to do any thing which thou knowest to be evil; so shalt thou always live jollily; for a good conscience is a continual Christmas.” –Ben Franklin

Epictetus quotes

"Men are disturbed not by the things which happen, but by the opinions about the things."

"Seek not that the things which happen should happen as you wish; but wish the things which happen to be as they are, and you will have a tranquil flow of life."

"Whoever then wishes to be free, let him neither wish for anything nor avoid anything which depends on others: if he does not observe this rule, he must be a slave."

THE TAPER: Recalibrating Liquidity - By Richard Duncan

The “Taper” has begun. It’s important to understand why.

On December 18th, the Fed announced that it will begin to taper the amount of fiat money it creates each month from $85 billion to $75 billion starting in January. Chairman Bernanke also indicated that the Fed is likely to continue reducing the monthly amount of money it creates by $10 billion at each future FOMC meeting – so long as the economy performs in line with his current expectations. That would bring QE3 to an end by December 2014.

The press has attributed the Fed’s decision to taper to an improvement in the outlook for the economy. I don’t believe that is the correct explanation. The recovery is still too weak and uncertain to justify tapering on those grounds. In my opinion, the real reason is to prevent excess liquidity from creating a new, destabilizing asset price bubble in stocks and property.

During 2013, the Fed has injected just over $1 trillion of liquidity into the financial markets through QE. Over the same period, the government has sucked nearly $700 billion of liquidity out of the markets by borrowing to finance its budget deficit. That left $300 billion of excess liquidity that was invested into other asset classes, most notably stocks and property. On top of that, a further $400 billion of liquidity entered the United States from abroad as a surplus on the country’s financial and capital accounts. (See Macro Watch Fourth Quarter 2013 for a detailed explanation.) This massive excess liquidty explains why the S & P 500 Index and home prices are up 25% and 13%, respectively, this year.

Hussman Weekly Market Comment: The Diva is Already Singing

Regardless of last week’s slight tapering of the Federal Reserve’s policy of quantitative easing, speculators appear intent on completing the same bubble pattern that has attended a score of previous financial bubbles in equity markets, commodities, and other assets throughout history and across the globe.

The chart below provides some indication of our broader concerns here. The blue lines indicate the points of similarly overvalued, overbought, overbullish, rising-yield conditions across history (specific definitions and variants of this syndrome can be found in numerous prior weekly comments). Sentiment figures prior to the 1960’s are imputed based on the relationship between sentiment and the extent and volatility of prior market fluctuations, which largely drive that data. Most of the prior instances of this syndrome were not as extreme as at present (for example, valuations are now about 35% above the overvaluation threshold for other instances, overbought conditions are more extended here, and with 58% bulls and only 14% bears, current sentiment is also far more extreme than necessary). So we can certainly tighten up the criteria to exclude some of these instances, but it’s fair to say that present conditions are among the most extreme on record.

This chart also provides some indication of our more recent frustration, as even this variant of “overvalued, overbought, overbullish, rising-yield” conditions emerged as early as February of this year and has appeared several times in the past year without event. My view remains that this does not likely reflect a permanent change in market dynamics – only a temporary deferral of what we can expect to be quite negative consequences for the market over the completion of this cycle.

Narrowing our focus to the present advance, what concerns us isn’t simply the parabolic advance featuring increasingly immediate impulses to buy every dip – which is how we characterize the psychology behind log-periodic bubbles (described by Didier Sornette in Why Markets Crash). It’s that this parabola is attended by so many additional and historically regular hallmarks of late-phase speculative advances. Aside from strenuously overvalued, overbought, overbullish, rising-yield conditions, speculators are using record amounts of borrowed money to speculate in equities, with NYSE margin debt now close to 2.5% of GDP. This is a level seen only twice in history, briefly at the 2000 and 2007 market peaks. Margin debt is now at an amount equal to 26% of all commercial and industrial loans in the U.S. banking system. Meanwhile, we are again hearing chatter that the Federal Reserve has placed a “put option” or a “floor” under the stock market. As I observed at the 2007 peak, before the market plunged 55%, “Speculators hoping for a ‘Bernanke put’ to save their assets are likely to discover – too late – that the strike price is way out of the money.”

John Mauldin: What Has QE Wrought?

Now that we have begun tapering, we will soon see lots of analysis about whether QE has been effective. What will the stock market do? The US economy seems to be moving in the right direction, but the Fed has forecast Nirvana (seriously) – do we dare hope they can finally get a forecast right? Or have they jinxed us? This and a few other dark thoughts crossed my path on a beautiful day in San Diego; so in a very different Thoughts from the Frontline, I offer a number of small gifts rather than an overarching theme, and we will see if we can keep it short.

Geoff West: Scaling Laws In Biology And Other Complex Systems

Link

Jim Chanos on CNBC

Links to videos:

Chanos: Bit of a banking crisis in China

Chanos: US market risks increased dramatically

Mark Hanson: Housing “Bubble 2.0″; Same as “Bubble 1.0″, only different actors

In this short note, I outline where my research is going at the first of the year supporting ideas about why a “strong economy” is negative for this housing market;  houses are far “more expensive” today then from 2003-2007 (i.e., “affordability” much worse); and how everybody has been “fooled by stimulus” and unprecedented monetary policy, yet again.

This report — which I am in the process of turning into a ppt presentation — establishes what US housing has really become over the past 12-years and in my opinion makes it far easier to time its unprecedented volatility and forecast the outcomes that since 2002 have fooled most of the people most of the time.

 This housing market is “resetting” right now;  for the third time in six years. It might look and feel a little different, but as I detail in this note, it’s not really different this time around.

2007 and 2009 interviews with Peter Bevelin

Below are the combined 2007 and 2009 interviews I did with Peter Bevelin, which I thought might be good to combine in one place, and to post in case any new readers have yet to see them. I seem to notice something new every time I read them, just as I do anytime I open Seeking Wisdom or Poor Charlie’s Almanack. I also created a PDF of the interviews HERE.

2007 Interview with Peter Bevelin

Q: In the introduction of your book, you mention that you owe a great debt to Warren Buffett and Charlie Munger and that if you had listened to them earlier in your life, you would have avoided many expensive mistakes. Could you elaborate a bit on how you first came across Warren and Charlie, how your process of learning from them began, and maybe even mention a couple of the mistakes that you may have avoided had you come across them earlier?

I first came across the name of Warren Buffett in 1986, when I was on a plane between New York and Miami and picked up Fortune Magazine in the seat in front of me. Back home in Sweden I immediately ordered Berkshire’s annual reports. But I was a slow learner. I didn’t really pick up his and Charlie Munger’s wisdom until I went to my first Berkshire annual meeting in 1994. What did I learn? – How to think about businesses and investing, how to behave in life, the importance of ethics and honesty, how to approach problems but foremost how to reduce the chance of meeting problems. As Munger says: “All I want to know is where I’m going to die so I’ll never go there.” When I hear them at the annual meeting, I am thinking about Einstein’s reply to a student. The student had challenged Einstein’s statement that the laws of physics should be simple by asking: “What if they aren’t simple?” Einstein replied, “Then I would not be interested in them.”  

They have a unique ability to distinguish masses of trivia from what is really important – to filter out situations, and find what’s at their core. They tell the simple, blunt truth rather than say things that sound good.

In the past, I complicated things too much, I put too much trust in people that really shouldn’t be trusted, I wasn’t skeptical enough , I bought into things merely because they were cheap etc. In short, I wasn’t thinking and I was lacking the Munger ability to un-learn my own best-loved ideas. The stock certificates of some of my earlier investments in private businesses are now used as lining in my old overcoat; at least they had a nice color. And is there really any other way to approach investments than their way? Turn it around and ask what are the effects of investing in things we don’t understand, lack advantages and have a dishonest and incompetent management and that can be bought at a high price.

I found that I could increase my chance of making better judgments if I could learn what works and not, if I adapt what I do to my personal situation, and if I could establish some values and preferences. If I then could set up some avoid-rules and filters/tests to judge what make sense or is important or not, life could be improved (even if I still do some mistakes; but hopefully I am less of a fool now). Also remember that all decisions aren’t important. Some people spend more time making a judgment on what TV to buy or where to go on vacation than a life-changing decision like marriage.

Q: Charlie Munger has mentioned that a great way to learn Adam Smith’s ideas is to first learn about Adam Smith. Do you believe that this idea of learning about the “teacher” before the “lesson” is truer in some disciplines than in others and do you have any examples when this method of learning was especially useful to you? 

Experiments have shown that we learn better if information is tied to a vivid story. So, I would say, it depends. In some cases the “Smith-model” is superior and in other cases I may learn better in some other fashion. For example, I learnt a lot from reading The Autobiography of Charles Darwin. But I also learnt a lot of Einstein’s ideas by reading Mr. Tompkins in Paperback by George Gamow. See also what I wrote about Reason-respecting (20 in the book). On the other hand, when reading, we must constantly watch out for the sensemaking trap (19 in my book) since we are so easily influenced when we are told stories or given information in a “story-format.” 

Q: As you state in the introduction, “This book is for those who love the constant search for knowledge. I have focused on explaining timeless ideas. The number of pages I have devoted to each idea does not reflect on its importance. My goal is to lay the foundation.” Once readers acquire the foundation they receive by reading Seeking Wisdom, where should they go next? Specifically, what is the first thing that you would recommend they should pick up to start learning more about the big ideas in the discipline of Math? Psychology? Physics? Biology? Chemistry? Economics? Engineering? Philosophy?

Look around you – observe reality. What can explain this? Learn some core concepts that account for reality. Start from the basics for each discipline and emphasize the understanding of general principles and use simple real-life examples to illustrate principles. Read, read and think about what you have read. Look for understanding. What is going on here? What is the core idea? What is the evidence that it is right? Also remember what Richard Feynman once asked someone who remarked that he had read a book. “But, did you learn anything?” Understand an idea’s meaning and applications. Focus on useful and obviously important and correct general ideas, concepts and principles. What does it mean? What happens? What is the effect? 

Q: As many value investors have been taught, it is more important to focus on the process of doing something instead of solely focusing on the outcome of that process. Do you have any tips that may help people along the process of “seeking wisdom?” Should someone focus their attention on learning many ideas from one or two disciplines at a time, or by learning many disciplines one or two big ideas at a time?

There are principles, which apply to all different kind of phenomena. For example, JB Williams’s definition of value is applicable for all financial assets. Personally, I started with biology and psychology since knowing some human constraints and “brain traps” I could avoid some things by for example using some “avoid-rules.” Why can’t we all be nice, honest and rational? (And why can’t we all have wings and thus eliminate department store escalators?). I favor ideas that explain a whole range of phenomena. For example, biology (evolution and natural selection) explains why people: fear losses but take big risks when threatened, fear strangers, trust similar people, cooperate, imitate, fear social disapproval, make fast judgments, and overreact to vivid information.

Also, some disciplines are more reliable than others. For example, disciplines describing experimentally tested ideas, concepts and principles.

Some other examples on disciplines and ideas that explain a lot: Mathematics (scaling) explain how living things are shaped and constrained by basic mathematical principles. For example, why: no giants exist, a mouse can survive a big fall but not a human, some animals have short and thick legs, larger plants have leaves, small animals can’t live in cold countries, ants can lift such a big load, and grasshoppers can jump so high relative to their body sizes. Mathematics (combinatorics) and Physics (systems theory) explain why: we can’t predict the economy, it is hard to make money on new ventures, most projects take more time and money than we anticipate, nuclear accidents happen, we will have more electrical black-outs, coincidences occur, and some mutual funds beat the index.

Q: Are there any books in which you believe the models presented within those books are so important that you make it a habit to re-read them every year or every couple of years?

All of Charles Munger’s speeches. Most of them can be found in Peter Kaufman’s Poor Charlie’s Almanack. I also re-read Hardin’s Filters Against Folly. 

Q: Can you give a Top 10 list of books that really changed the way you view the world?

Some books that I really learnt a lot from (in no order of preference):

Cialdini Robert B., Influence: The Psychology of Persuasion 

Darwin Francis (editor), The Autobiography of Charles Darwin and Selected Letters 

Dawes Robyn M., Everyday Irrationality: How Pseudo-Scientists,Lunatics, and the Rest of Us Systematically Fail to Think Rationally (it really introduced me to the value of always asking: Why should I believe this? – Show me the evidence + Compared to what?)

Feynman Richard, The Character of Physical Law and The Meaning of it All: Thoughts of a Citizen Scientist 

Hardin Garrett, Filters Against Folly: How to Survive Despite Economists, Ecologists, and the Merely Eloquent 

Lowenstein Roger, Buffett: The Making of an American Capitalist 

Montaigne Michel de, The Complete Essays 

Nassim Nicholas Taleb, The Black Swan  

Q: Can you talk a little about the process of writing your book? I think you did a magnificent job of pulling things together into a logical and understandable order and I imagine it was quite the experience organizing all the models that you have acquired over the years from your mind down on to paper.

Gene Fowler once said: “Writing is easy. All you do is stare at a blank sheet of paper until drops of blood form on your forehead.” Most people can do what I did. I am not especially smart or talented. It just takes curiosity and real interest. After being inspired by Charles Munger’s lectures on worldly wisdom (from Outstanding Investor Digest), and after reading Darwin, I took some time off business and started reading books in biology, neuroscience, psychology, and physics. As Warren Buffett once said: “I think you can learn a lot from other people. In fact, I think if you learn basically from other people, you don’t have to get too many ideas on your own. You can just apply the best of what you see.” Then I wrote down what I learned – I put together some key thoughts as a crude working model (what I found was that I couldn’t really synthesize things sitting in front of the computer. Like Arthur Schopenhauer said: “Thoughts die the moment they are embodied by words.” I could only see various connections between things and the big picture when I was out walking thinking about something else). Since sorrow feels worse than happiness feels good, I concentrated on learning causes of what I wanted to avoid – things with huge consequences.

I also spent some time visiting the Neurosciences Institute in La Jolla where I got some real understanding of how our anatomy, physiology and biochemistry constraints our behavior. I also interacted with a lot of science people via the Internet. Remember, I did this not to write a book, but to improve my own thinking and as a kind of memorandum to my children. I had no time constraints. And I loved it! Exploring and learning new things give me great satisfaction. When I started to read and write some of my friends said: what’s that good for? Why do you waste time studying that? How can that help you make money? Usually I don’t like to answer these questions, not because I don’t believe that the basic insight into how things work will not pay off at some time, but because I believe that acquiring insight is in itself a worthwhile effort. As Benjamin Franklin said: “ If a man empties his purse into his head, no one can take it away from him. An investment in knowledge always pays the best interest.”

Q: Finally, is there anything people may be surprised to know about you? Any unique interests?

People immediately assume that merely because I have written a book containing a lot of science, I must be a professor or an academic. I am not. Regarding any unique interests – nothing that would interest your readers.

I wish you and your readers a happy day – Everyday!

**********

2009 Interview with Peter Bevelin

If we make the assumption that Warren Buffett is going to be running Berkshire Hathaway for another 20-30 years, what advice would you give a 20-30 year-old today in regards to what he or she needs to learn over those years to be capable of taking over the job for Warren when he retires? And what qualities will be especially useful for seeing those risks that are important, but have never happened before? And why did Munger once say that Warren is a better investor than him?

I always try to remember what Munger once answered to a question: “I don't have any special competence that would enable me to answer that question." And I can’t answer your question on Buffett. Buffett is what Munger calls a Lollapalooza. If you go back and read the notes from the Wesco annual meeting in 2007, you get some clues on what factors contribute to his greatness (also by reading Poor Charlie’s Almanack, created by Peter Kaufman).

I may be wrong, but I don’t think I am totally wrong, but I believe there are some general characteristics that are important to reduce investment sorrow (no order of importance and not considering the eternal virtues of price, management and moat). Some examples:

1. The importance of knowing what you know and don’t know. There is a lot of wisdom in this remark from Eitan Wertheimer: “I had a very big lesson from Warren: the use of the word discipline…We learned very quickly that our most important asset is our limitations…The second thing we understand is that when we respect our limitations we don’t suffer from them anymore.”

2. Not putting all your trust in checklists (causing a false sense of security and control, just like wearing a seat belt makes drivers feel more secure, making them drive faster or more recklessly). Trouble often comes from the direction we least expect. I like this fable by Aesop:

“A Doe who had had the misfortune to lose the sight of one of her eyes, and so could not see anyone approaching on that side, made it her practice to graze on a high cliff near the sea. Thus she kept her good eye toward the land on the lookout for hunters, while her blind side was toward the sea whence she feared no danger. But one day some sailors were rowing past in a boat. Catching sight of the doe as she was grazing peacefully along the edge of the cliff, one of the sailors drew his bow and shot her. With her last gasp the dying doe said: "Alas, ill-fated creature that I am! I was safe on the land side, whence I looked for danger, but my enemy came from the sea, to which I looked for protection.”

Montaigne said: “Death can surprise us in so many ways.” For example, recurring revenue streams may stop or long-term customers may disappear. Remember what has happened to newspapers. As Alice Schroeder wrote on Buffett in The Snowball: “He tended to extrapolate mathematical probabilities over time to the inevitable (and often correct) conclusion that if something can go wrong it eventually will."

3. Related to the above is the importance of resilience and redundancy. Let me exemplify by some quotes from our heroes:

Munger: “'Of course you prefer a business that will prosper even if it is not managed well. We are not looking for mismanagement; we like the capacity to withstand it if we stumble into it... having a margin of safety running through the whole system.. All our super-cat policies have limits – meaning the maximum we can pay under a single policy. We can add up all those maximum limits. And when we get to a number that would make us squirm in our seats, we stop writing it… We try and operate so that it wouldn’t be too awful for us if something really extreme happened – like interest rates at 1% or interest rates at 20%… We try to arrange [our affairs] so that no matter what happens, we’ll never have to “go back to go.”

Buffett: “We want to always keep a lot of money around. We have so many extra levels of safety we follow at Berkshire…. in financial markets, almost anything that can happen does happen. And it pays to conduct your affairs so that no matter how foolish other people get, you’re still around to play the game next day.”

Try to follow the advice of Confucius: “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.”

4. Pascal’s lesson as told by Buffett: “If we can't tolerate a possible consequence, remote though it may be, we steer clear of planting its seeds.”

5. Absence of a need to invest all the time. As Buffett said: “You only have to do a few things right in your life as long as you don’t do too many things wrong.” Also, Seneca said: “The mind must be given relaxation; it will arise better and keener after resting.”

6. Knowing what to avoid. As Buffett recently said on Wells Fargo: “The real insight you get about a banker is how they bank. You've got to see what they do and what they don't do. Their speeches don't make any difference. It's what they do and what they don't do. And what Wells didn't do is what defines their greatness.” Isn’t that wise? My favorite Munger quote on this is: “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

7. Temperament is more important than intelligence. As Buffett said: “Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior are vital to long-term investment success.”

8. Keynes’ advice: “It is better to be roughly right than precisely wrong.”

9. Thinking like a businessman and investor. As Buffett said: "Being a businessman makes me a better investor and being an investor makes me a better businessman."

10. Keeping things simple. I love this Munger quote: “We use a lot of experience and do it [investment returns] in our heads. We don’t like complexity and we distrust other systems and think it many times leads to false confidence. The harder you work, the more confidence you get. But you may be working hard on something that is false. We’re so afraid of that process so we don’t do it.”

11. Understanding the fundamental importance of trust to life and business. As Oliver Wendell Holmes said: “Put not your trust in money, but put your money in trust.” And to quote Seneca in the choice of friends: “After friendship is formed you must trust, but before that you must judge.” Think about how much life is improved by being around people you can trust. Or to invert – think about the misery of being around people you can’t trust. And it simplifies life. As Munger said: “When you get a seamless web of deserved trust, you get enormous efficiencies.”

12. An ability to tune out folly and noise. For example, physicists have a wonderful ability to eliminate unimportant details and focus on what matters. Professor Douglas Hofstadter once said that thinking is all about the ability to look at complex situations and strip away things that don’t count – the ability to filter out situations, and [find] what’s at their core. Something Buffett and Munger are extremely good at.

In your opinion, why is there so much difference in opinion when it comes to economics? For example, conservative, liberal, and the Austrian School economists all seem to have dramatically different economic theories on causes and solutions to crises. Is economics a science that hasn’t evolved enough, one that has evolved too quickly, or are their other factors that keep smart people from coming to even a general consensus?

Since economics is not an exact science (if it is a science at all) there exist a lot of opinions, ideas and therefore different “schools” and personal beliefs and ideologies. How could it be otherwise?

Many of the big ideas in economics, like Ricardo’s principle of comparative advantage and Smith’s idea on the gains from specialization and division of labor, are hundreds of years old. Then something happened. As the 18^th century Irish statesman Edmund Burke said: “The age of chivalry has gone: the age of economists, sophists and calculators has arrived.” Not much has happened since then except that now economics focuses on econometrics and statistics. After World War 2, mathematics was turned into an obsession where economists overemphasized techniques over ideas. But reality is a little bit too messy to be put into an equation. There is too much uncertainty. Too many factors and possible outcomes (see more about this in part three of my book). As Keynes said: “Too large a proportion of recent “mathematical” economics are mere concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.”

Their models may be rigorous but the key is whether they are useful. Is it physics envy? I would characterize it more as mathematics envy. Physicists are more empirical. Economists imitate mathematicians in their effort to try to prove theorems. It is more applied mathematics than science. Furthermore, economists often forget side effects, as they call it, meaning effects they didn’t foresee or didn’t want to think about. But as Buffett has said over and over again: “The most important question in economics is, “And then what?”

Let me end with Keynes again:

"I also want to emphasize strongly the point about economics being a moral science. I mentioned before that it deals with introspection and with values. I might have added that it deals with motives, expectations, psychological uncertainties. One has to be constantly on guard against treating the material as constant and homogeneous. It is as though the fall of the apple to the ground depended on the apple's motives, on whether it is worth while falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the center of the earth."

Several books have come out within the past year, such as Outliers, Talent is Overrated, and The Talent Code, which discuss the concept of greatness and the process it takes to achieve it. They basically say that the key to achieving greatness is a very specific kind of really hard work, or deliberate (or deep) practice, assuming one is in a position to perform that kind of deliberate practice (which is often a factor of luck and culture). Can you comment on the kind of deliberate practice activities you think: (1) makes a great investor; (2) it takes to be an overall great thinker? Also, can you give an example of the type of work you put in when trying to master a particular mental model?

Please, tell me the secret formula on how to get rich, be the best thinker, lose weight, have a happy marriage and solve all my problems quickly. There are no secret formulas or shortcuts and beware of the articulate incompetents and false prophets – they sound impressive and clever but lack substance. I can only refer to what Buffett said in the foreword to Poor Charlie’s Almanack: “From 1733 to 1758, Ben Franklin dispensed useful and timeless advice through Poor Richard's Almanack. Among the virtues extolled were thrift, duty, hard work, and simplicity.” Of course, Munger’s views on how to get worldly wisdom help.

Personally, I read a lot. I have to work things out for myself to understand them. I try to use the “see one, do one, teach one” approach used in medical education (but change it to “do many” and in multiple situations and over time). I often go from reality (something I have seen) to find answers among ideas. I don’t try to fit reality to an idea. And then I try to find more examples on an idea from reality. Finally, I try to explain it to someone else. Writing Seeking Wisdom was such an exercise – I forced myself to learn by teaching someone else. And reading Feynman at an early point helped me where I clearly learnt the difference between knowing the name of something and knowing what goes on since knowledge is only valuable if it’s useful and something is only useful if I understand what it means. What I in my book called meaning and asking, “what happens?”

I try to concentrate on learning practical and consequential things that can help me reduce the chance of sorrow.

When you talk about deliberate practice or working on what you’re bad at, just remember this Munger quote: “Each of you will have to figure out where your talents lie. And you’ll have to use your advantages. But if you try to succeed in what you’re worst at, you’re going to have a very lousy career. I can almost guarantee it. To do otherwise, you'd have to buy a winning lottery ticket or get very lucky somewhere else.” Also, as Munger said, what often causes greatness or a Lollapalooza is when many factors work together in the same direction (as in the case of Buffett).

In a recent interview with Bill Gates and his father, the elder Gates mentioned two traits that he thought really described his son’s success: curiosity and hard work. An intense curiosity has also been used to describe so many of the great minds throughout history, such as Ben Franklin, Darwin, Einstein, Feynman, among many others (including Buffett and Munger). Can you describe what you’re currently curious about? And is there anything you became more curious about while curiously writing your book?

I have a peculiar kind of mind that is continuously curious. Especially on things that relate to human nature and the brain in all its colors. For example, one thing that presently fascinates me is the workings of placebo and nocebo. And isn’t this fascinating – after you have read this you will never be the same. Not that my answers will have any dramatic impact but I am talking about the fact that all experiences modify the brain.

When I wrote Seeking Wisdom, I got more curious about DNA-testing and diagnostic screening and the uncertainties involved.

I have been reading a lot about the ancients and their wisdom lately. On and off I write on a memo for my children and myself. I call it “THE WISDOM SEEKER: Uncommon Sense from the Ancients to Munger.” It is about a man who wants to become wiser and visits a place I call “The Library of Wisdom.” In the library he meets and learns from wise people like Cicero, Newton, Einstein, Munger, etc. Reading ancient history has reinforced the notion that people’s behavior stays the same. As the saying goes - "Plus ça change, plus c'est la même chose" or the more things change, the more they stay the same - just different actors.

I believe Charlie Munger has mentioned that if he could live another lifetime, he may spend most of it trying to fix the education system. I know it is a complex and detailed subject, one that Bill Gates said in a recent interview is his hardest one to solve, but could you give a couple of things that you think schools, on any level, should do better?

What do we need to teach? A preparation for real life; that is [composed of] useful knowledge of practical consequence, not recitation of facts. The purpose of education is not to fill the minds of students with facts – it is to teach them to think, and to think for themselves. To quote James Clerk Maxwell: “It is very necessary that those who are trying to learn from books the facts of physical science should be enabled to recognize these facts when they meet them out-of-doors.”

We need to learn some general and time-tested principles. Any theory or model that doesn’t work in practical reality should be banned. Practical applications are key. If what a student learns isn’t tied to reality, he cannot possibly remember what he has learned. And then a student needs to practice what he learnt.

Any educational experience must also tell stories – teach from real life situations from the experiences of others. We don’t pay attention to boring things. To quote Horace Mann: “A teacher who is attempting to teach without inspiring the pupil with a desire to learn is hammering on a cold iron.” We need more drama in class and more stories on failures, before we make them ourselves. Like the air flight simulator but when it is complemented with pilots hearing from other pilots (stories) who failed in real life. The U.S. Army conducts “After Action Reviews” that enable participants to analyze, discuss, and learn from both the successes and failures of a variety of military initiatives. Hospitals use "Morbidity and Mortality" conferences (in which physicians convene to discuss significant mistakes or unexpected deaths) as a forum for identifying, discussing, and learning from failures. And when a plane crashes, investigators retrieve the flight recorder and try to find out what went wrong. Why doesn’t academia learn more from failures?

Instead of teaching formulas to solve problems, wouldn’t it be better to teach the student the art of thinking and where to look for answers to various problems? And wouldn’t it be better to teach students that most of life’s problems have no easy solutions? And to teach them to learn to know when they know something and when they don’t?

Of course, I may be totally wrong. Like Cicero said: “No one can speak well, unless he thoroughly understands his subject.”

Have you come across any big ideas, in any field of study, within the last couple of years that have altered some of your previously held beliefs, or reinforced those that you already had?

One thing that has been reinforced is how hard it is to change people’s opinions or beliefs. On the other hand, this is understandable. As the author Jacob Braude said: “Consider how hard it is to change yourself and you’ll understand what little chance you have of trying to change others.” The lesson? It is better to avoid situations where we need to change people. Also, in the end, each of us has to respect that others may disagree with us.

Also, how quick we are in drawing conclusions. For example, I am often too quick in being judgmental and forget how I myself behaved or would have behaved if put in another person’s shoes.

Another thing that has been reinforced is how much uncertainty and randomness there is in the world. But what also has been reinforced – especially during the financial crisis– is how hard it is to accept this. I am referring to our hate of uncertainty and the unknown or our strong psychological need a) for control of what will happen to us, b) for reasons why something happened and c) to know what will happen in the future.There is a poem by Miroslav Holub that well illustrates our need of a map of hope – a sense of control so uncertainty is reduced:

Albert Szent-Gyorgyi, who knew a lot about maps according to which life is on its way somewhere or other, told us this story from the war due to which history is on its way somewhere or other:

The young lieutenant of a small Hungarian detachment in the Alps sent a reconnaissance unit out into the icy wasteland.

It began to snow immediately, snowed for two days and the unit did not return. The lieutenant suffered: he had dispatched his own people to death.

But the third day the unit came back.

Where had they been? How had they made their way?

Yes, they said, we considered ourselves lost and waited for the end. And then one of us found a map in his pocket. That calmed us down.

We pitched camp, lasted out the snowstorm and then with the map we discovered our bearings.

And here we are.

The lieutenant borrowed this remarkable map and had a good look at it. It was not a map of the Alps but of the Pyrenees.

Personally, I try to improve my understanding of what really can be explained or usefully predicted and what can’t. And sometimes finding an answer doesn’t mean anything or doesn’t lead to a rational course of action.

Can you describe the importance of skepticism in this world? It seems that it is so easy to fall for a good story and fall for the sensemaking trap described in your book. Do you have any red flags or checklists you use in these situations? I think you may have touched on one in our previous interview: Why should I believe this? – Show me the evidence + Compared to what?

First of all, I try to follow Pascal’s philosophy – only be skeptical about matters that really can hurt me if I’m wrong. So by this, I eliminate a lot – I don’t even think about it. Second, I try to learn how to recognize crap, including my own. There are many things I don’t do or think about – elimination is a great conservator of effort.

Generally, keep it simple and use some filters. Some questions I ask myself: Is it important? If yes, is it knowable? If yes, is this within my circle of competence? Which of course assumes that I know what I know and can do, and what I don’t know and can’t do. Otherwise I exclude and throw it in to too hard pile. If within, then, any testable argument should be tested – What is the evidence? Can I disprove it? Compared to what (including negative cases and non-events)? Randomness content? If I believe this, what would follow? What would I have to check out? What ideas can help me? I wrote more about this in part three of my book.

Take medicine and research as an example where my skepticism has increased. For example, there is a great article by John Ioannidis - Why Most Published Research Findings Are False.

(http://www.plosmedicine.org/article/info:doi/10.1371/journal.pmed.0020124)

Montaigne best illustrates another “filter” - assumptions are useful but only to the extent that they are valid: “I realize that if you ask people to account for ‘facts’, they usually spend more time finding reasons for them than finding out whether they are true… They skip over the facts but carefully deduce inferences. They normally begin thus: 'How does this come about?' But does it do so? That is what they ought to be asking.”

Also regarding making comparisons, take Robyn Dawes’ discussion on the crash of Western Airlines Flight 903. He says that to find out the cause of the crash, we have to compare the crash with cases where no accidents happen. For example, just because pilots are often tired before a crash doesn't give us any insights if it is important, unless we know they are often not tired before a safe landing. (There is a good interview with Dawes called, Ethics, science, and the helping professions: a conversation with Robyn Dawes.)

http://findarticles.com/p/articles/mi_hb3060/is_1_39/ai_n29007242/?tag=content;col1

In our previous interview, you gave a great list of books from which you learned a lot. Which books have you read in the last couple of years that you have also learned a lot from and can recommend for our readers?

I read so many books but to mention a few I liked. The Strategist by Robert Dodge - about the Game Theorist Thomas Schelling. The Electric Life of Michael Faraday by Alan Hirshfeld. Niall Ferguson’s The Ascent of Money, The Choice by Eliyahu Goldratt, Brain Rules by John Medina. Joshua Cooper Ramo’s The Age of the Unthinkable, and The Match King by Frank Partnoy. The most recent book I read was The Invisible Hook by Peter Leeson. It’s about pirates. It clearly showed that there was honor among thieves. Rules, incentives and disincentives were needed for proper functioning. As you can see I read all kind of books. It’s fun!

Finally let me end with some wise words from the Greek historian Herodotus: “If a man insisted always on being serious, and never allowed himself a bit of fun and relaxation, he would go mad or become unstable without knowing it.”

Many Thanks and I wish you and your readers a happy, healthy and prosperous life.

May 31, 2009

Peter Bevelin