You Have To Live It To Believe It Part 2 of 2
By Morgan Housel Apr 9, 2019
Part 2: Can We Ever Learn?
The big question is: Which investing group is better off? The veterans who lived through a crash and came out paranoid, or the newbies who never experienced it and are now willing to take bigger risks?
I don’t think there’s ever a clear answer to that question.
Long-term business and investing skill is the intersection of getting rich and staying rich. Different generations whose formative experience was calm and growth-oriented may be better at getting rich – they’re willing to take risks.
But generations whose upbringing was punctuated by crash and decline may be more attuned to staying rich – conservatism, room for error, and rational pessimism. The best investors find a balance between the two, toggling between the two traits at the right time. But that’s rare.
And the reason it’s rare even among smart people is because the psychological scars of our experiences don’t discriminate on IQ. Or more specifically, they sit above IQ in the information hierarchy that people use to make decisions.
Michael Batnick has made the point that having experienced a big event doesn’t necessarily make you better prepared for the next big event. Few bond investors – even grizzled veterans – have lived through a sustained rise in interest rates. But, he writes:
So what? Will the current rate hike look like the last one, or the one before that? Will different asset classes behave similarly, the same, or the exact opposite?
On the one hand, people that have been investing through the events of 1987, 2000 and 2008 have experienced a lot of different markets. On the other hand, isn’t it possible that this experience can lead to overconfidence? Failing to admit you’re wrong? Anchoring to previous outcomes?
It’s never clear one way or another. People with different experience than us aren’t necessarily smarter. They just see the investing world through a different lens.
Part of why learning through experience isn’t necessarily good or bad is due to the lessons we take away from experience.
Jason Zweig of The Wall Street Journal once noted:
I often like to say that people are too good at learning lessons, and the lesson that people should have learned after the Internet bubble burst in early 2000 was that day trading is a really bad idea.
But people are too good at learning lessons, so they learned an overprecise lesson, which was that day trading Internet stocks is a really bad idea. So in recent years we see the same people who day-traded internet stocks going into day-trading foreign currency.
I have a theory about why this hyper-specific learning happens.
My son is three. He’s amazing. But he’s three. So he doesn’t know very much.
What’s amazing about a three-year-old is that they learn fast, but virtually everything they know came from what they’ve observed and experienced firsthand. He’s never sat through a history lecture, spent an afternoon analyzing stock charts, or had a long dinner with someone from another country.
Everything in his head came directly from an experience he’s had. He therefore has no idea how most things work. Imagine trying to get him to understand the nuances of NATO; impossible. Or LIBOR; can’t do it. Enormous, important chunks of the world do not exist in his brain. He has no concept of them.
But he doesn’t walk around confused all day. He understands his world perfectly. It’s a world shaped by, and explained with, the few mental models he’s picked up in his three years. Ice cream is good. Blankets are warm. Toys are fun. Naps are not. I don’t need a bath.
That’s his world. And everything he comes across fits into one of those simple three-year-old mental models that he’s built in his head.
When his parents tell him it’s time to put his toys away, or that he can’t eat ice cream for breakfast, his frustration is caused by experiencing something that doesn’t fit into his mental models. Ice cream is good, so if mom says I can’t have it, that’s not good and I’m going to cry.
He has no concept of a balanced diet, or the consequences of a poor diet, even if we explain it to him. But, in the moment, he’s not looking for an explanation. He’s trying to match the world he lives in to a mental model he has in his head.
Even though he knows almost nothing, he doesn’t realize it, because he tells himself a coherent story about what’s going on based on the little he does know.
And we all do this, regardless of age.
I don’t know what I don’t know. No one does. But we can’t walk around confused all day. Nassim Taleb says “I want to live happily in a world I don’t understand.” Which is exactly what we do. We take the world we live in and try to make a coherent story out of it based on the mental models we’ve developed during our lifetimes.
Those models are only useful when they’re simple. That’s when they become automatic. Complex, nuanced models – like the art of negotiating – are hard. But simple ones like “say thank you when someone helps you” – are easy to grasp.
This is where Jason’s point comes back in. Specific lessons are easier to build mental models with, so they’re what we take away from experience. Learning that you’re susceptible to the siren song of bubbles is hard and nuanced.
But learning that “tech stocks hurt me so I should avoid tech stocks in the future” is an easy lesson. My son could pick it up. It doesn’t matter that it’s not a very good lesson. It’s an easy one, so we use it.
There’s a related issue here about how we process the memories of our experiences.
In his book on World War II, historian Joseph Balkoski writes that “One firm lesson that serious World War II researchers have learned is that the reliability of human memory varies drastically from one veteran to the next.” Veterans recalled experiences that were verifiably false.
Time, Balkoski writes, “can play subtle tricks on the mind, and the historian’s thorniest problem is to separate those rare fully substantiated accounts from the more typical yarns that time has established.”
Daniel Kahneman calls this the “experiencing self” and the “remembering self.” They can be two completely different minds.
Memories of big events are influenced by a few punctuated moments, not the full story. Kahneman once gave the example of a study showing how people remember colonoscopies:
[What influenced memories was] determined completely differently from what we would have thought. It was simply an average of the worst moment in the colonoscopy, and how badly it hurt when the procedure ended.
Those two variables really gave you excellent prediction of, when you ask people, “Would you want to have another one of those, or would you rather have another painful procedure?” Or you ask them, how much total pain was it? How bad was the whole experience?
He later wrote:
The experiencing self is the one that answers the question: “Does it hurt now?” The remembering self is the one that answers the question: “How was it, on the whole?” Memories are all we get to keep from our experience of living, and the only perspective that we can adopt as we think about our lives is therefore that of the remembering self.
An investing version of this came a few years ago. The S&P 500 gained 27% in 2009 – a fantastic return. Yet when asked in early 2010, 66% of investors thought it fell that year, according to a survey by Franklin Templeton. The market then rose 31% in 2013. That was the fifth-best annual return since World War II.
But a 2014 Gallup poll asked 1,000 active investors how much they thought it increased, and only 7% knew the gain was over 30%. One-third thought it was flat or declined.
Perhaps the explanation for this gap between experience and memory is the market trauma that took place in early 2009, or the political circus of 2013, scared investors enough to create specific memories that were stronger and easier to recall than the actual overall experience. It’s also an example of relying on mental models that are simple and easy to recall, even if they’re not complete.
The imperfect side of memory complicates the question of “can we learn lessons without experiencing events?” It’s not even clear that people who experience big events can learn from their own past. They can be influenced by their past in a way that guides their future decisions. Learning is something different.
But let’s assume you go out of your way to be as open-minded as possible, becoming a student of history and putting yourself in others’ shoes. Can you learn?
Yes, of course. But there are endless asterisks.
The hardest part of studying history is that you know how the story ends, often before you begin researching a topic. And I don’t think you can un-remember that fact when reading about an event.
Particularly difficult is attempting to put yourself in someone’s shoes and imagining their emotions when you know how the story ends but they, at the time, did not.
SEAL Team 6 gained fame after it killed Osama Bin Laden. Video games and movies were made glorifying the raid. But President Obama later said the odds placed on whether Bin Laden was actually in the target house were 50/50. Last year I heard one of the SEALS involved in the mission speak at a conference.
He said, regardless of whether Bin Laden was in the house, the team felt the odds they’d all be killed in the mission were also 50/50. So here we have a 75% chance that the raid would have ended in disappointment or catastrophe.
Which is not something the people creating glorified video games of an epic adventure think about. They highlight the badass success and glory, because that’s how the story ended. But no one knew that before or during the raid.
A corollary in business and investing is that there is a thin line between bold and reckless. The hindsight view of outcomes can blind us to other scenarios that easily could have happened, which makes learning lessons about how much risk we should take in the future difficult.
I can say “2009 taught us that you should buy when there’s blood in the streets.” But it’s easy to forget how bad the financial crisis was, and how different the outcome could have been.
Fed chairman Ben Bernanke allegedly told a group of congressmen in 2008 to prepare for martial law within 48 hours if the banking system were allowed to collapse. That’s the kind of thing that’s easy to forget as we look back and learn lessons.
Same with business. We think Mark Zuckerberg is a genius for turning down an offer to sell Facebook to Yahoo. But people criticize Yahoo with as much passion for turning down its own buyout offer from Microsoft. Hindsight is the only difference between the two. What is the lesson for entrepreneurs here? I have no idea. I don’t think anyone does. That’s the point.
“The customer is always right” and “customers don’t know what they want” are both accepted business wisdom. Examples of both are only known with hindsight, and it’s impossible to think about these topics with an open mind when you know the eventual outcome of how certain products perform.
Another hard part about learning vicariously is that there’s a difference between learning and learning so well that it compels you into action.
A 13-year-old girl being killed by a drunk driver is something everyone reading this article will agree is atrocious. Yet virtually all of us will say it’s atrocious without taking further action.
But Candace Lightner’s daughter was that 13-year-old girl, so she created Mothers Against Drunk Driving to do something about it. Personal experience is often what pushes you from “I get it” to “I get it so well that I’m going to do something about it.”
Same in investing. Spreadsheets can model the historic frequency of big declines. But they can’t model the feeling of coming home, looking at your kids, and wondering if you’ve made a mistake that will impact their lives. Studying history makes you feel like you understand something.
But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior.
Anchoring to your own history is not a problem with a clear and simple answer.
There is no, “Just do X and you can overcome this problem.”
It’s one of those things where the best we can do it to become a little more aware of its presence.
Going out of your way to speak with people whose backgrounds are different than yours, knowing that their view of the world may look nothing like your own, though they are just as sure of their views as you are of yours, is a humbling thing.
But it’s so important to expand your mind to the range of possibilities you may come across as an investor. I think it’s probably the most important kind of learning an investor can accomplish – going out of their way to figure out what kind of worldview and experience they haven’t had that others who have just as much influence over market outcomes have had.
As Jim Grant says, “Successful investing is getting others to agree with you … later.” If those other people will never agree with me because their personal history blinds them to my view, then my view and my forecasts may never become reality.
A practical side of this is having room for error in your decisions and forecasts, knowing that your view of the world is a tiny fraction of all the other views that can influence the economy.
Another takeaway is remembering that people whose views and decisions look crazy to you may be less crazy than you think, because they’re being made by people whose views on risk and reward were shaped in a different world than you’ve experienced.
I don’t understand why someone would want to put all their money into gold after the financial crisis, or crypto in recent years.
But my financial experience is probably different than people who have done those things. I don’t get why anyone would want to become a lawyer, or a zoologist, or a pilot; those things don’t appeal to me at all.
But maybe all lawyers and zoologists and pilots experienced something in their life that made those jobs appealing. And maybe they’d be appealing to me if I had those same experiences.
When you realize that other people can make decisions that look crazy to you but make perfect sense to them because they’ve experienced something you haven’t, you become less cynical about the investing industry and more focused on whatever works for you.
We should always try to make people better informed, but with the idea that people with the same information will often come to different conclusions.
“Personal finance is more personal than it is finance,” says Carl Richards. To each their own. I always try to remember that before criticizing others’ decisions.
"Your yesterday was not my yesterday, and your today is not even my today,” writes the book Our Kids.
When the study was over the blind cats were left in a fully lit room. Forty-eight hours later, all were effectively normal, regaining their “vision” and learning how to match the world around them to their movements.
Eight weeks of seeing their world taught them virtually nothing. Two days of experiencing it, and they had it all figured out.
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