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One of the most important aspects is second-level thinking. The art of investing has a characteristic that is not usually appreciated: an admirable result, even if not spectacular, can be achieved by the lay investor with a minimum of effort and ability. However, improving this easily attainable standard requires a lot of dedication and much more than just a stroke of wisdom.
( B. Graham, The Intelligent Investor) Everything should be done in the simplest way possible, but not too simple. ( Albert Einstein) It's not meant to be easy; it's stupid to think it easy. (Charlie Muni) Few have the vocation to be great investors. Some can be taught, but not all, and those who can be taught, there's no way to teach everything.
Valid approaches work sometimes, not always. Furthermore, there's no way to reduce the act of investing to an algorithm and hand it over to a computer; even the best investors don't always get it right. The reasons for these limitations are simple: there are no rules that work in all cases; the environment is not controllable, and circumstances rarely repeat themselves exactly the same way; psychology plays an important role in the markets, and cause-and-effect relationships, being highly variable, are not reliable.
An investment approach may work for a while, but there will come a time. The actions it demands will change the environment, revealing the need to seek a new approach. Furthermore, the effectiveness of an approach is reduced when others begin to imitate it. Investing, like economics, is more art than science.
This means it can cause some confusion. One of the most important things to keep in mind today is that economics is not an exact science; it may even not be a science at all, in the sense that in science it is possible to conduct controlled experiments, replicate past results with confidence, and ensure the maintenance of cause-and-effect relationships.
The eWork Will Work (March 5, 2009). Considering that investing is at least both an art and a science, I have no intention of suggesting in this book or anywhere else that we can make investments through routine actions. In fact, one of the things I most want to emphasize is the great importance of taking an intuitive and adaptable investment approach instead of a predetermined and mechanistic one.
Ultimately, everything depends on what you intend to achieve. Anyone can achieve average performance simply by investing in an index fund that buys a little of everything; this will give you what is known as... Market returns are simply about matching the market, but successful investors want more; they want performance above market indices.
This is beating the market. I believe this is the definition of successful investing: having better performance than the market and other investors. To achieve this, it is necessary to have good luck or exceptional perception. Relying on luck is not a great plan, so the best thing to do is to focus on perception.
In basketball, they say it's impossible to train people's height, meaning that no coach in the world will be able to make a player taller. It's almost as difficult as teaching people perception, as in any other art form. Some people know how to invest better; they have acquired that necessary attraction of wisdom that Ben Graham discusses.
Everyone wants to make money. The entire economy is based on the belief in the universality of the profit motive, and so is capitalism. The profit motive makes people work harder and risk their capital. The pursuit of profit has produced much of the material progress in the world. However, because of this universality, beating the market—that is, having performance above market indices—is not about simply matching the market.
It's a difficult task; millions of people compete for every available dollar. Who will win? The person who is one step ahead of the others in some activities. Being the best means having more education, spending more time at the gym or library, being better nourished, sweating more, having more stamina or better equipment, investing.
However, one area where these things don't matter much is an activity that requires more perceptive thinking—something I call second-level thinking. Future investors can take finance and accounting courses, read a lot, and, if they 're lucky, receive mentorship from someone with a deep understanding of the investment process.
But only a few of them will have the excellent perception, intuition, psychological sense of value, and awareness that are necessary to consistently achieve above-average results. For this, second-level thinking is necessary. Remember that we don't want to obtain average returns when investing. We want to be above average.
So your thinking needs to be better than others'; it must be more powerful and at a higher level. Since other investors may be intelligent, well-informed, and highly computerized, you need to find some advantage they don't have: think about something they don't know, see things they don't see. Those who managed to see or perceive what they didn't perceive need to react and behave differently.
In short, being right may be a necessary condition for investment success, but it won't be enough. You must be more right than others, which by definition means your thinking has to be different. What is second- level thinking? First-level thinking says, " This is a good company, let's buy shares." Second-level thinking says, " This is a good company, however everyone considers it a great company, and it isn't, therefore its shares are overvalued and overestimated, let's sell." First- level thinking says, "The scenario demands low growth and increased inflation, let's sell our shares." Second-level thinking says, "The scenario is bad, but everyone else is selling because they are panicking, let's buy." First-level thinking says, "I think the company's profits will fall, sell." Second- level thinking says, "I think the company's profits will decrease less than people expect, and this pleasant surprise will make the shares rise, let's buy." First-level thinking is simplistic, superficial, and common to almost everyone, and that's not a good sign for anything involving an attempt at superiority.
First-level thinkers need an opinion about the future, such as whether the scenario for the company is favorable and therefore the shares will rise. Second-level thinking is deep and complex. This level of thinker takes many things into account: What is the range of probable future outcomes? What outcome do I think will occur?
What is the probability of me being right? What is the consensus? In what aspects does my expectation differ from the consensus? How does the current asset price behave based on the consensus view of the future and my view? Is the consensus psychology embedded in the price too optimistic or pessimistic?
What will happen to the asset price if the consensus is right and if I am right? The difference in workload between first- and second- level thinking is clearly gigantic, and the number of people capable of performing the latter type of thinking is small compared to the number of people capable of performing the former.
First-level thinkers seek simple formulas and easy answers; second- level thinkers know that investing well is the antithesis of simplicity. This doesn't mean that you won't find many people trying their best to make investing seem simple. I call some of these people... From mercenary brokers to those who try to convince their clients that everyone is capable of investing at $10 per transaction, mutual fund companies don't want their clients to feel capable of investing successfully; they want them to believe that only they can.
In this case, money is put into actively managed funds, which charge high management fees. Others, which simplify things, are what I call elitist approaches. Some are academics who teach about investing, others are well-intentioned practitioners who overestimate the extent to which they are in control.
I believe most cannot determine the sum of their track records, or ignore bad years, or attribute their losses to bad luck. Finally, there are those who simply cannot understand the complexity of the subject. A guest commentator on the radio station I usually listen to in the car said the following: "If your experience with the product was good, buy shares of the company." However, to be a good investor requires much more than just that.
First-level thinkers think the same way as other first-level thinkers on the same topics; in general, they arrive at the same conclusions. By definition, this cannot be the case. To achieve the best results, it is impossible for all investors to outperform others. Market level, because collectively they are the market.
Before trying to compete in a zero-sum investment world, we need to ask ourselves if we have a good reason to be part of the top half. To outperform the average investor, we need the ability to think better than the consensus. Are you capable of doing this? Why do you believe this? The problem is that extraordinary performance is born only from correct non-consensual predictions.
But non-consensual predictions are difficult to make correctly and require difficult action. Over the years, many people have told me that the following chart had a great impact on them: it is not possible to do the same things that others do and expect to outperform them. Unconventionality should not be an end in itself, but rather a way of thinking.
To differentiate ourselves from others, we need to have different ideas and process them differently. I describe the situation in a two-multiply-two simple chart. Although nothing is so easy and so clear, I believe this is the general situation: if our behavior is conventional, we will probably achieve conventional results, good or bad.
Only if your behavior is unconventional is your performance likely to be unconventional, and only if your judgments are superior is your performance likely to be. Above Average darit B great aous sser grande September 7, 2006 The result is simple: for investments to have superior results, we need to have non- consensual opinions about value, and they must be accurate.
This is not easy. The attractiveness of buying something for less than it's worth makes perfect sense. So how do we find bargains in efficient markets? For this, we need to have exceptional analytical skills, perception, or forecasting abilities. However, few people have this exceptionality. Rees and How They Get That Way.
Returns and How They Become What They Are November 11, 2002 For performance to diverge from the norm, your expectations, therefore your portfolio must follow the same path, and you need to be more certain than the consensus. Different is better. This is a good description of second-level thinking. Those who consider the investment process as something simple are not usually aware of the need or even the existence of second-level thinking.
Thus, many people are deceived and led to believe that everyone can be a successful investor, but not everyone succeeds. The good news is that the prevalence of first-level thinkers raises the returns available to second-level thinkers. To consistently achieve superior returns on investment, we must be one of these...
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