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ОглавлениеSIMPLICITY IS THE ULTIMATE SOPHISTICATION
Most geniuses—especially those who lead others—prosper not by deconstructing intricate complexities but by exploiting unrecognized simplicities.
—Andy Benoit
Life is really simple, but we insist on making it complicated.
—Confucius
Simplicity is the result of long, hard work, not the starting point. The ability to reduce something to its essence is the true mark of understanding. But one of the great ironies in life is that when the smartest minds generously share the secrets of their success with us, we ignore them, because they sound too basic and simple for us to appreciate.
“That’s it? It can’t be so simple!” we say, when we hear them giving us simple advice to achieve greatness.
Consider investing. When we read Warren Buffett’s revelation of the only two rules of successful investing—“Rule number 1: Never lose money. Rule number 2: Never forget rule number 1”1—we protest, “Great thought, but is that it? It can’t be so simple!”
Investing is simple, but not easy.
—Warren Buffett
In an interview with Business Wire in November 2011, Buffett said, “If you understand chapters 8 and 20 of The Intelligent Investor (Benjamin Graham, 1949) and chapter 12 of The General Theory (John Maynard Keynes, 1936), you don’t need to read anything else and you can turn off your TV.”2 This advice from Buffett references two classics from the field of investing and economics.
Chapter 8 of Graham’s book talks about not letting the mood swings of Mr. Market coax us into speculating, selling in panic, or trying to time the market.
Chapter 20 explains that, after careful analysis of a company’s ongoing business and its prospects for future earnings, we should consider buying only if its current price implies a large margin of safety.
In chapter 12 of The General Theory of Employment, Interest, and Money (“The State of Long-Term Expectation”), Keynes remarks that most professional investors and speculators were “largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public.”3
Buffett took the simple but fundamental truths of investing from these three chapters quite seriously and applied them throughout his life, with a high degree of intensity, and it has made him one of the wealthiest individuals in the world.
Take a simple idea and take it seriously.
—Charlie Munger
The simple ideas with intensity of pursuit is what gets you to the promised land.
—Mohnish Pabrai
Buffett’s key takeaway from The Intelligent Investor was this: If you eliminate the downside, then all that remains is the upside. After that, the key is to keep emotions in check and be patient. It really is that simple.
It’s simple but not easy.
In the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand.
—Benjamin Graham
Many newcomers in the investing field consider The Intelligent Investor to be too dry and not “exciting” enough. It does not reveal any secrets to finding the next big multi-bagger, and it does not offer any shortcuts for making money quickly. But, as I have realized through my multiple readings of this book, it does build the character and steely resolve required to become a good investor. And character building, as compared with wealth building, is a much more difficult subject to read about and practice. (For the former, refer to Rudyard Kipling’s poem “If” in appendix B.)
Mohnish Pabrai’s book The Dhandho Investor is one of the more accessible books written on value investing. Just like Buffett, Pabrai has a gift for simplifying complex sounding ideas. In his book, he writes:
Every business has an intrinsic value, and it is determined by the same simple formula. John Burr Williams was the first to define it in his The Theory of Investment Value published in 1938. Per Williams, the intrinsic value of any business is determined by the cash inflows and outflows—discounted at an appropriate interest rate—that can be expected to occur during the remaining life of the business. The definition is painfully simple….
Simplicity is a very powerful construct. Henry Thoreau recognized this when he said, “Our life is frittered away by detail…simplify, simplify.” Einstein also recognized the power of simplicity, and it was the key to his breakthroughs in physics. He noted that the five ascending levels of intellect were, “Smart, Intelligent, Brilliant, Genius, Simple.” For Einstein, simplicity was simply the highest level of intellect. Everything about Warren Buffett’s investment style is simple. It is the thinkers like Einstein and Buffett, who fixate on simplicity, who triumph. The genius behind E = mc2 is its simplicity and elegance.4
The Simplest Solution Often Tends to Be the Best
The grand aim of all science is to cover the greatest number of empirical facts by logical deduction from the smallest number of hypotheses or axioms.
—Albert Einstein
Occam’s razor, named after fourteenth-century English logician William of Ockham, is a principle of parsimony, economy, or succinctness used in logic and problem solving. It states that among competing hypotheses, the hypothesis with the fewest assumptions should be selected. Other, more complicated solutions ultimately may prove to provide better predictions, but in the absence of differences in predictive ability, the fewer assumptions that are made, the better.
Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count [emphasis added]. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables.
—Warren Buffett
The way Buffett deals with difficult problems is to avoid them altogether. Unlike the figure skaters at the Olympics, we don’t get extra points for higher degrees of difficulty in investing. Originality and complexity are not necessary or sufficient conditions for generating superior long-term returns. As investors, our job is simply to compound capital over time at the highest possible rate with the minimum amount of risk. We achieve this objective by seeking out undervalued stocks of companies within our circle of competence. Be completely indifferent to whether the market cap is large or small or to whether the company is relatively unknown or widely followed.
Investing is not about being original or creative; it is about looking for the greatest amount of value (for the price paid) with the least amount of risk. Putting in more time and effort does not guarantee better results in investing. Rather, it is more beneficial to do less and make fewer but better choices.
The more decisions you make, the less willpower you have. It’s called decision fatigue. Focus on making fewer and better decisions. This allows you sufficient time to think about each decision deeply and reduces the chances of making a mistake. We should restrict ourselves only to those cases in which the investment decision looks like a no-brainer. As Charlie Munger says, “The goal of investment is to find situations where it is safe not to diversify.”5
Look for simple businesses that require fewer assumptions and fewer hypothetical scenarios to work out and that do not require discounting cash flows from way out into the future to justify the investment. As Thomas Carlyle aptly put it, “Our main business is not to see what lies dimly at a distance, but to do what lies clearly at hand.” In his 2004 letter, Buffett highlighted the importance of sticking to simple propositions:
If only one variable is key to a decision, and the variable has a 90 percent chance of going your way, the chance for a successful outcome is obviously 90 percent. But if ten independent variables need to break favorably for a successful result, and each has a 90 percent probability of success, the likelihood of having a winner is only 35 percent…. 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.6
It is important to identify and focus on the few key variables that really matter to an investment decision. This vastly simplifies the process and improves the probability of a successful outcome. The Occam’s razor mental model is useful because it enables us to separate the long-term signal from the short-term noise and to calmly think through any investing decision. Yes, reading the annual reports, filings, press releases, and footnotes to the accounts is important, and occasionally, we will be able to dig out some extra detail that might give us an analytical advantage, but, in my view, understanding the big picture (the two to three key variables that really matter) is equally, if not more, important. Some of us may be average at business valuation but still can achieve above-average results by being able to better put the available information in the appropriate context, by remembering the big picture, and by being able to pinpoint the few factors that really matter to an investment.
In one of his lectures at Columbia University, Joel Greenblatt taught his students the importance of always keeping the big picture in mind: “Explain the big picture. Your predecessors failed over a long period of time. It has nothing to do about their ability to do a spreadsheet. It has more to do with the big picture. I focus on the big picture. Think of the logic, not just the formula.”7
In investing, simplicity is the way to long-term success. Buffett says: “The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective…. We haven’t succeeded because we have some great, complicated systems or magic formulas we apply or anything of the sort. What we have is just simplicity itself.”8
Simplicity is the art of thoughtful reduction. It is a systematic falsification of deeply held beliefs. Conan Doyle’s fictional character Sherlock Holmes once said, “If you eliminate the impossible, whatever remains, however improbable, must be the truth.” In contrast, complexity opens you up to far more possibilities and surprises, possibly in a harmful way.
Buffett has been emphasizing the idea of simplification for a long time. He wrote in his 1992 shareholder letter, “We try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we’re not smart enough to predict future cash flows. Incidentally, that shortcoming doesn’t bother us.”9
Munger agrees: “We have a passion for keeping things simple. If something is too hard, we move on to something else. What could be more simple than that?”10
Observe how Munger is able to greatly simplify the path to wealth creation: “Spend less than you make; always be saving something. Put it into a tax-deferred account. Over time, it will begin to amount to something. This is such a no-brainer.”11
Intelligent people are drawn to complex solutions. Plenty of smart and highly educated people work in the world of finance. But that intelligence often comes at a cost, because smart people can more easily fool themselves into believing they have all the answers. That can get them into big trouble. As Albert Einstein said, “If you can’t explain it simply, you don’t understand it well enough.”
According to William James, “The art of being wise is the art of knowing what to overlook.” This is true not just for business problems but for people as well. As Buffett cautions, “You can’t make a good deal with a bad person.”12 This is precisely the philosophy he has followed in his business and personal life. He has chosen to work only with people he admires and trusts. As a result, he has rarely had to deal with nasty problems created by bad people.
Although Occam’s razor is a useful mental model, it should not be seen as a substitute for empirical testing. It relies on subjective assessment of simplicity and looks for approximate or “good enough” solutions to the problems at hand (also known as “satisficing”). It is not a rule. It is more of a guide or a suggestion.
Sherlock Holmes would look for the simplest, most natural explanation for a case, but he also believed in not oversimplifying complex matters, especially when dealing with systems involving complicated interactions.
Similarly, Albert Einstein believed in the power of simplicity, but he also understood its limitations: “Everything should be made as simple as possible, but no simpler.”
For example, the reason for the popularity of the price-to-earnings (P/E) ratio is its simplicity and accessibility. A ratio of 20× simply means that a company is available at a market capitalization that is twenty times its annual earnings. In other words, the stock price is trading at twenty times its earnings per share. The P/E ratio in isolation, however, tells us nothing about the business’s capital intensity, cash flow generation, management quality, or balance sheet strength, or about the expected duration of its competitive advantage period. There’s a lot more to making money in the stock market than just looking at P/E ratios. (Every investor should diligently study the white papers titled “What Does a Price-Earnings Multiple Mean?” and “The P/E Ratio: A User’s Manual” by Michael Mauboussin and Epoch Investment Partners, respectively.13)
Three Steps to Simplification
Complexity is about tactics; simplicity is about systems. Tactics come and go but an overarching philosophy about the way the world works can help you make better decisions in multiple scenarios. Simple doesn’t go out of style but complex does.
—Ben Carlson
The first step in simplification is to avoid wasting time on things that are unknowable and unimportant. Before attacking a problem, ask whether it is important and worth solving. Buffett explains, “There are two questions you ask yourself as you look at the decision you’ll make. (A) Is it knowable? (B) Is it important? If it is not knowable—as you know, there are all kinds of things that are important but not knowable—we forget about those. And if it’s unimportant, whether it’s knowable or not it won’t make any difference. We don’t care.”14
Which way the interest rates will move, what the stock market is going to do next, where the economy is headed, and so on, are all important but unknowable.
The second step for simplification is focus. When we try to accomplish too many things simultaneously, we end up doing all of them poorly. Attention is a scarce resource that gets depleted throughout the day. Yet, we act as if it can be divided unlimitedly with no negative consequence. Decision-making is more effective when we focus on one thing at a time. Multiple research studies have shown, time and again, that the human brain is not optimized for multitasking, especially when one is working on complicated and unfamiliar tasks. One of the hardest things to do in life is to avoid good opportunities so that you have time to devote to great opportunities—and having the wisdom to know the difference.
Buffett’s secret to success is his intense focus—instead of doing more, he does less. He once told his personal airplane pilot, Mike Flint, that Flint needed to do three things to reach his goals. The first was to write down his top twenty-five goals. The second was to circle the top five most important ones. Finally, he should separate the top five goals into a separate list—and put goals six through twenty-five on a “not-to-do” list. Buffett concludes by stating: “Everything you didn’t circle just became your ‘avoid at all cost list.’ No matter what, these things get no attention from you until you’ve succeeded with your top 5.”15
We have so many things in our life that we want to do. Who wouldn’t want to succeed at twenty-five different things? But when we chase after twenty-five things at once, that’s when we run the risk of becoming a jack-of-all-trades but a master of none. Our society rewards excellence and specialization. You need to excel at only a few chosen skills. And this is why Buffett’s “not-to-do list” is so helpful. Items six to twenty-five on your list are probably all important things that you care about. But when it comes to items one to five, items six to twenty-five are a distraction. Spending time on secondary priorities is the reason we have twenty half-finished projects instead of five completed ones. As the Pareto principle states, “80 percent of your results come from 20 percent of your activities.” Focus on the top 20 percent of activities and deprioritize the bottom 80 percent.
The not-to-do list concept is similar to the primary idea behind Gary Keller and Jay Papasan’s book The ONE Thing. It debunks the theory that multitasking is the path to success. Instead, ask yourself, “What is the most important thing I can do today? What is the one thing that would make everything else in my life either easier or unnecessary?”
The difference between successful people and very successful people is that very successful people say no to almost everything.
—Warren Buffett
When you say no, you are saying no only to one option. When you say yes, you are saying no to every other option. So be careful to what and to whom you say yes. This choice eventually will shape many things in your life. Every day we have the opportunity to make choices and shape our future; every day is the first day of the rest of our lives.
The third step for simplification is to reason backward. Instead of trying to arrive directly at the solution, begin by eliminating the options that are not correct. You get an enormous advantage by narrowing your problem space. You can then focus your time and attention on the more productive areas.
Let’s be honest. We don’t know for sure what makes us successful. We can’t pinpoint exactly what makes us happy. But we know with certainty what destroys success or happiness. This realization, as simple as it is, is fundamental: Negative knowledge (what not to do) is much more potent than positive knowledge (what to do).
—Rolf Dobelli
To make good investing decisions, you need to actively look for reasons not to buy the stock in question. Invert, always invert. Simplifying helps us make better decisions by breaking down complex problems into component parts. For example, I ask four inverted questions whenever I am looking at a stock. These questions break the mind-set of trying to find supportive bullish reasons and force me to actively seek out disconfirming evidence.
1. How can I lose money? versus How can I make money? If you focus on preventing the downside, the upside takes care of itself.
2. What is this stock not worth? versus What is this stock going to be worth? If you can identify the floor price or a cheap price for a stock, it’s far easier to make profitable decisions.
3. What can go wrong? versus What growth drivers are there? Rather than focusing just on the growth catalysts, think probabilistically, in terms of a range of possible outcomes, and contemplate the possible risks, especially those that have never occurred.
4. What is the growth rate being implied by the market in the current valuation of the stock? versus What is my future growth rate assumption? A reverse discounted cash flow fleshes out the current assumptions of the market for the stock. We can then compare the market’s assumptions with our own and make a decision accordingly.
Good investors demonstrate the flexibility to completely change their opinions if necessitated by the facts. They don’t hope they will be right; they keep evaluating why they might be wrong. A good source for disconfirming evidence (from which I have greatly benefited) is the analysis provided by vigilante investors on social media. These investors tend to express bearish or skeptical commentary on almost every single company they review. Another useful source for disconfirming evidence is short-seller or negative reports on the stocks I am contemplating buying or those on which I am bullish. Seth Klarman has spoken in the past about the benefit of this source of information:
From our experience, much long-oriented analysis is simplistic, highly optimistic, and sloppy. Short-sellers, by going against the long-term tide of economic growth and the short-term swells of public opinion and margins calls, are forced to be crackerjack analysts. Their work product is usually top-notch and needs to be. Short-sellers shouldn’t be reviled or banned; most should be celebrated and encouraged. They are the policemen of the financial markets, identifying frauds and cautioning against bubbles. In effect, they protect the unsophisticated from predatory schemes that regulators and enforcement agencies don’t seem able to prevent.16
Simplicity as a Way of Life
It is very simple to be happy, but it is very difficult to be simple.
—Rabindranath Tagore
To attain knowledge, add things every day; to obtain wisdom, remove things every day.
—Lao Tzu
Have you ever considered that there are way too many things that you need to evaluate day after day? Too many news items, too many questions, too many possessions, too many options for everything, too many stocks from which to choose, too many investment products that too many financial advisers want you to buy.
If that is the case with you, what you need to bring peace to your life is minimalism.
Minimalism is basically an extension of simplicity—you not only take things from complex to simple but also try to get rid of anything that is unnecessary. Few things in life really matter. Because few things matter, we must think carefully about what really matters to us and then commit our time primarily to those things. That way, we will remain focused on what matters rather than chasing the new thing, which probably will not really matter. The goal is not to have the fewest number of things but to have the optimal number of things.
Practicing minimalism has brought peace and simplicity to my life. I cherish it for the time it has freed up for me to focus on those aspects that are more meaningful to me—giving more time to my family, friends, personal health, and learning activities.
From traveling with less personal luggage, eating less junk food and sugar, and using fewer apps on my mobile phone to having fewer stocks in my portfolio, I have embraced minimalism as a way of living. I already can see the immense benefits of clarity, focus, and efficiency that this has brought to my life. To me, minimalism is about living with less stress. The fact that it saves money is just an added benefit.
Do you hold more than fifty stocks, spread across multiple brokerage accounts? I urge you to simplify. Have you invested in more than ten different mutual fund schemes? I urge you to simplify. Have you invested in numerous “investment plans” whose “original purpose” was to provide life and health insurance? I urge you to simplify. Have you, over time, piled up loads of defunct, useless stuff on your office desk or at your home? I urge you to simplify. Clearing the clutter from the various aspects of our lives reduces decision fatigue and sharpens our focus on what we really want to achieve.
There is no path to peace. Peace is the path.
—Mahatma Gandhi
Minimalism in life isn’t a destination to reach, it is the path to follow.
Practicing and adopting minimalism as a way of life is simple.
It’s simple but not easy.
You cannot become a minimalist overnight. But, as Lao Tzu said, “A journey of a thousand miles begins with a single step.”
The parable of the Mexican fisherman and the American banker is one of my favorite stories and contains an important life lesson. It is habitual for most of us to build incessantly and forget that the endgame should really be happiness and a fulfilling life. It is equally easy to overlook all the goodness we are surrounded by today.
It doesn’t take a lot of money to have a truly wealthy life, but it does take financial independence, which gives us control over our time. This is the important topic that we will address in the next chapter.
