Friday, 19 January 2018

Exit humility; enter mental flexiblity

It is often said that successful investors require a paradoxical blend of confidence and humility. Confidence, it is argued, is essential so that an investor is able to maintain the courage of their convictions, and have the fortitude to go against the crowd when necessary. Humility, though, is said to also be an important counterweight, because a willingness to change ones views and admit that they are wrong is also absolutely essential. It is argued that too much unchecked confidence can lead to disastrous outcomes - too much risk taking, and an inability to correct mistakes.

While I agree with the broad notion that is being argued for here, I think the contradistinction of confidence with humility is flawed in a subtle but important way, and that in truth, humility has no rightful place in a successful investor's mental repertoire. Allow me to explain.

I completely agree that confidence is absolutely essential. Successful investing requires one to unselfconsciously back their judgement, in much the same way that a successful cricket batsman must cast aside all self-doubt and play his or her natural game without hesitation (one of my favourite quotes from the movie Troy is Hector's enjoinder to his younger brother Paris, right before the latter entered into a duel to the death: "You think of your sword, and his sword, and nothing else").

Self-doubt opens the door to emotional vulnerability during the recurrent bouts of market uncertainty that are wont to occur, and at worst can lead to capitulation during market dislocations. It is absolutely toxic to investment performance. If you cannot back yourself in markets, you have no business operating in them. You will be slaughtered.

Where I disagree is that I do not believe the correct counterbalance to confidence is humility. Humility has too much in common with a lack of self confidence, and has excessive and unnecessary negative connotations. Humble folk often lack confidence, and it is wrong, in my view, to say that successful investors must be paradoxically both confidence and unconfident at the same time. Indeed, I do not believe there to be any paradox at play at all.

Instead of humility, what is really needed is open-mindedness and mental flexibility, and a willingness to change one's views when new evidence presents itself that suggests one might be in error. You will often be wrong in markets, and just as importantly, events are constantly evolving, as new facts and evidence steadily emerge. This requires one to engage in a constant process of mental evolution, updating one's views as new and better information comes to light (Peter Lynch used to liken the process to playing poker - when a new card hits the table, the odds change, and one needs to reassess the situation and have the flexibility to adapt to changed circumstances). 

What really must be avoided in the markets, at all costs, is not a lack of humility, but dogmatism and ideology. Dogmatic and ideological individuals are so sure that they are right and already have all the answers, that they will often close their mind off to alternative perspectives; ignore disconfirmatory evidence; and dismiss any notion that they might possibly be wrong. Often, their identities and egos are intimately intertwined into their belief systems and convictions, which heavily impairs their mental flexibility and willingness (and arguably, ability) to change their minds. This is what markets punish - not a lack of humility, but a lack of mental flexibility and open-mindedness

It ought to be possible to be both confident and mentally-adaptable at the same time, even in the absence of humility. John Maynard Keynes - never renowned for his humility - was perhaps the most famous exponent of this, with his immortal rejoinder in the face of an accusation of inconsistency: "When the facts change I change my mind. What do you do, Sir?".

An idealised example of the correct approach is this: A confident but open-minded, mentally-flexible individual might believe X with a high degree of confidence, because it is based on factual premises A, B, and C, and the individual has a sound basis for being confident that each of these factual premises is correct. Furthermore, after carefully-considered reasoning, the individual believes X flows inexorably from A, B, and C through the use of sound deductive logic.

However, the said individual will openly acknowledge that conclusion X is fundamentally dependent on A, B, and C being correct, and that none of these three underlying premises can be known with absolute certitude. Furthermore, the said individual will be open to considering any new evidence that might suggest A, B, or C were in fact not true after all (or any argument that the chain of deductive logic used to derive conclusion X therefrom might contain an important fallacy).

If, though this process, compelling evidence comes to light that suggests A, B, or C might in fact be false, or that an error in reasoning is present, suddenly, in an instant, the open-minded individual will acknowledge that their prior conclusion X can no longer be held with conviction, and might very well be wrong. No humility is necessary, provided there is a constant acknowledgement that one's view of the world is imperfect, and in need of constant revision. This is how one can be both confident and mentally-adaptable at the same time. This is the necessary approach in markets, and there is no inconsistency, incompatibility, or paradox between the two attributes.

A more concrete example might be the following: I am an atheist, and I am highly confident that I am right in this assessment. However, if tomorrow, God was to part the clouds and reveal himself to me and others, I would change my mind in an instant (well - almost - I would have to first consider the possibility that I was hallucinating or otherwise mentally impaired; if that possibility could be discounted, then I would change my mind). That's not humility. That is adapting one's views to the presence of new evidence.

The scientific methods works in much the same way. Religious folk - perhaps the most dogmatic folk of all in society - like to criticise the scientific community for changing its conclusions regularly. But mental flexibility and a willingness to change one's mind to conform with new, better evidence, is a sign of mental strength, not weakness. It's like me saying this: I am thinking of a number between 1 and 100. You guess 50. I say too high. So you guess 25. I say too low. And you guess 38, and so forth. You've now changed your estimate three times, but you're getting closer to the truth as new evidence emerges. You are more likely to be right if you do this iteratively than if you stick to your first guess. 

Dogmatism and ideology, incidentally, is exactly what David Einhorn's famous 'No Broken Thesis' rule is designed to combat. The rule, in short, is that there should be a clearly-articulated thesis behind every investment, and if that thesis is subsequently invalidated, the stock should be sold. It is designed to combat the situation where a new thesis is invented to replace the old. This mental bait and switch is very common amongst humans, both inside and outside the investment world: people very often do not want to change their conclusions, and so instead, they change their reasoning to maintain the same conclusion (religious folk are particularly guilty of this). I believe Einhorn's No Broken Thesis rule to be flawed in some important respects (a topic for another blog post), but to the extent it is designed to guard against creeping dogmatism, he is absolutely spot on.

A big part of the problem stems from the social stigma our society attaches to admitting one is wrong, and changing one's views. It is still seen as a sign of mental weakness, instead of being properly regarded as a sign of mental strength. That ought to change.* However, if one wishes to be a successful investor, they absolutely must get over it. However, they need not become humble. 


*Sam Harris has suggested that social media, in addition to like/dislike buttons, should have a button that allows viewers to indicate that the piece of media in question has changed their mind or in some way influenced their thinking, and that as a society, we should encourage people to view this as a positive demonstration of open-mindedness. I think that is a fabulous idea.  Incidentally, I recommend Sam Harris' podcast Waking Up very highly (I support Sam on Patreon) - he is a polymath with a formidable intellect, and one of the most articulate speakers on the face of the planet.


  1. Hi Lyall, great post as usual and I agree with your conclusions for people in the ‘normal’ spectrum for emotional responses. Interestingly some studies suggest the best investors can often apply a cold machine-like logic and rather than being confident they are able to apply likely/expected value to each scenario without emotional interference. Often these individuals treat investing as a game that they are trying to win. I worked with a bloke like this once and he has an excellent investment record over a long time frame.

    1. Thanks Andrew,

      The outcomes from those studies don't surprise me at all. Ultimately, the best outcomes in investing come from removing emotions from the process as thoroughly as possible. Easier said than done as most people are highly emotional when it comes to money. The more coldly rational one can be the better.

      It is no coincidence, in my view, that some of the best investors, like Buffett, are (somewhat ironically) not materialistic. I think that allows them to disengage their emotions from the investment process much more easily than someone that is playing the game mostly for (especially quick) financial gain.