Financial Role Models

This note has been rattling around in my head for months and there have been many different versions of it. Some were thought up before bed, others on the subway, some even between tasks at work. I even started a few Word documents, but just couldn’t get my thoughts organized in a way I felt was compelling.

Part of the reason for this writer’s block is that I’ve recently become a father. This is a massive life milestone! It comes with a lot of strong emotions and new demands. Having an hour (or the several hours necessary) to sit down and organize your thoughts is something in much shorter supply these days. I also find that I think about the future a lot more and in different ways than I did even a few short months ago.

This life change has coincided with hearing some truly phenomenal speakers. I’m talking hearing from multiple people on my “Mount Rushmore of Greatest Investors”. I’ve been fortunate enough to hear from Howard Marks, Warren Buffett, and most recently Patrick Pichette (who I hadn’t heard of a few months ago but who’s thinking blew me away immediately) all since December.

Further, I’ve been reading a book on Mental Models and how you can borrow and apply the thinking techniques of some of the smartest people who’ve ever lived.

So where does all this lead? How does it all tie together?

I’ve been working on boiling down the ideas and thought processes of some truly great minds I’ve come across in books, white papers, and talks.

It’s said you should “never meet your heroes” however I completely disagree. You should have realistic expectations surrounding your heroes. Borrowing their thinking in one area where they have a demonstrated track record of excellence is very different than seeing them as “superpeople” lacking flaws. Always remember, your greatest weakness is usually the inverse of your greatest strength.

The below represent some of the learnings from my personal investing role models.

Warren Buffett

Think long-term.

Use decades, not quarters as your timeline.

Staying more than solvent with a comfortable balance

“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”

Circle of Competence
The power of consumer franchises:

“If people ask for your product by name, you’re going to have better margins.”

Further Reading: The Essays of Warren Buffett: Lessons for Corporate America

Howard Marks

Being a contrarian doesn’t mean opposing consensus views blindly, it means thinking things through for yourself from first principles.

Further reading: I Beg to Differ.

Where are we in the cycle?

Think probabilistically around upside vs. downside.
Discern between the wisdom and the madness of the crowd.
“The worst deals are made during the best times.”

Further Reading: The Most Important Thing

Ray Dalio

The power of Principles.

This was an awesome book that encourages you to write down your logical thought processes and track your results.
Sharing these insights with others to find gaps in your knowledge.
“Radical Truth” and “Radical Transparency” are uncomfortable, but they are the best way of uncovering what is true.

Keep things simple and work from first principles.

Ex. How the Economic Machine Works.

A 30 minute video that’s better than a macroeconomics course that anyone should be able to follow along with.

Believability-weight new information.

Don’t treat everyone’s insight the same.
Those who have had repeatable success in an area should be believed more than others who have not done something or have had mixed results.

Further Reading: Principles

Morgan Housel

Investing is not the study of finance; it's how people behave with money.
If your expectations grow faster than your income, you'll never be happy with your money.

Before the fraud, Bernie Madoff was making ~$30M/year from his legitimate business.
Fraud came AFTER this was his situation.

Risk is what you don't see. The biggest risk is something nobody is talking about.

Said different: The Lucretius Problem.
“The Lucretius Problem is a mental defect where we assume the worst-case event that has happened is the worst-case event that can happen. In so doing, we fail to understand that the worst event that has happened in the past surpassed the worst event that came before it.”

Further Reading: The Psychology of Money

Patrick Pichette

Identify the huge trends and their impacts on your business.

“Talent hits a target no one else can hit; Genius hits a target no one else can see.” – Arthur Schopenhauer

This is the story of Gmail users getting 1GB of storage for free at launch. Investors thought it would bankrupt the company but Patrick knew technology would catch up to their plan by the time they hit mass adoption.

Nassim Taleb

Don’t go bust. (The Black Swan)

Never make bets large enough to wipe you out. Once you’re out of the game, it’s over.
“A turkey is fed for 1,000 days by a butcher; every day confirms the turkey’s model that the butcher loves turkeys ‘with increased statistical confidence.’ The turkey’s confidence of a comfortable and predictable life is at an all-time high up until the week before Thanksgiving when his model of reality is quickly revised right before being slaughtered. This surprise is an example of a Black Swan event; but just for the turkey, not for the butcher.”

The world is a lot more random than you think. (Fooled by Randomness)

Be very skeptical and never mistake luck for skill.

Ex. A third party asks 2 individuals to "assume that a coin is fair (i.e., has an equal probability of coming up heads or tails when flipped). I flip it ninety-nine times and get heads each time. What are the odds of my getting tails on my next throw?"

Dr. John says that the odds are not affected by the previous outcomes so the odds must still be 50:50.
Fat Tony says that the odds of the coin coming up heads 99 times in a row are so low that the initial assumption that the coin had a 50:50 chance of coming up heads is most likely incorrect. "The coin gotta be loaded. It can't be a fair game."

Make asymmetric bets. (Antifragile)

Antifragile systems have consistent (but small) downsides and massive (but less frequent) upsides.

Source: Innolution

“Skin in the Game” is a precondition. (Skin in the Game)

Chefs need to eat their own cooking.
Would you invest in a fund or company where the PMs or senior leaders aren’t invested alongside you in a serious way?

Further Reading: Each of the above ideas is linked to a book in his “Incerto” series. Whichever idea resonates with you most, they are all great books.

George Soros

Theory of Reflexivity: there is a positive feedback loop between investor expectations to reality.

“The participants’ views influence the course of events, and the course of events influences the participants’ views. The influence is continuous and circular; that is what turns it into a feedback loop.”
Ex. rising home prices induced banks to increase their home mortgage lending and, in turn, increased lending helped drive up home prices. Without a check on rising prices, this resulted in a price bubble, which eventually collapsed, resulting in the financial crisis and Great Recession.

Trends are self-reinforcing until a moment of peak madness. At this point, everyone wakes up and realizes how disconnected their views are from objective reality (and the pendulum overswings in the opposite direction).

“By contrast, a positive feedback process is self-reinforcing. It cannot go on forever because eventually the participants’ views would become so far removed from objective reality that the participants would have to recognize them as unrealistic. Nor can the iterative process occur without any change in the actual state of affairs, because it is in the nature of positive feedback that it reinforces whatever tendency prevails in the real world. Instead of equilibrium, we are faced with a dynamic disequilibrium or what may be described as far-from-equilibrium conditions. Usually in far-from-equilibrium situations the divergence between perceptions and reality leads to a climax which sets in motion a positive feedback process in the opposite direction. Such initially self-reinforcing but eventually self-defeating boom-bust processes or bubbles are characteristic of financial markets, but they can also be found in other spheres. There, I call them fertile fallacies—interpretations of reality that are distorted, yet produce results which reinforce the distortion.”

Further Reading: The Soros Lectures at the Central European University

www.fairwaywealth.ca

The information contained herein was obtained from sources we believe to be reliable, but is not guaranteed by us and may be incomplete. The opinions expressed are based on our analysis and interpretation of this information and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. The opinions expressed herein are those of the author and do not necessarily reflect those of National Bank Financial.

The securities or investment sectors mentioned herein are not suitable for all types of investors. Please consult your investment advisor to verify whether the securities or sectors suit your investor's profile as well as to obtain complete information, including the main risk factors, regarding those securities or sectors. This document is not a research analysis produced by the Research Department of National Bank Financial.

National Bank Financial - Wealth Management (NBFWM) is a division of National Bank Financial Inc. (NBF), as well as a trademark owned by National Bank of Canada (NBC) that is used under license by NBF. NBF is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Investor Protection Fund (CIPF), and is a wholly-owned subsidiary of NBC, a public company listed on the Toronto Stock Exchange (TSX: NA).

Insurance products and services are provided by National Bank Insurance Firm (NBIF). NBIF is not a member of the Canadian Investor Protection Fund (CIPF). Insurance products are not protected by CIPF. Please note that comments included in this newsletter are for information purposes only and are not intended to provide legal, tax or accounting advice.

Insurance products and services are provided by NBF Financial Services (NBFFS). NBFFS is not a Member of the Canadian Investor Protection Fund (CIPF). Insurance products are not protected by the CIPF.

NBF is not a tax advisor and clients should seek professional advice on tax-related matters, including their personal situation. Please note that comments included in this letter are for information purposes only and are not intended to provide legal, tax or accounting advice. The comments reflect the opinion of their author only and may not reflect the views of NBF.