Accepting Randomness

Accepting randomness can provide comfort. It is when something is malicious that it really works me up. When the intention was to specifically make my life worse. That is very seldom the case. 

I like the idea of where people carry a coin to help them make difficult decisions, that are in truth 50/50. No matter how much analysis you do, it is simply a fork in the road, and you pick or get stuck. Once you know most of the advantages and disadvantages, you can’t craft an option that doesn’t have drawbacks. Keep moving. Pulse. 

Admitting the role of randomness is not a weakness. It is a way of accepting that it is not possible to control everything, and as Nightbirde says, “It’s okay”. Create meaning in the movement. 

Read “Fooled by Randomness” and learn about Black Swans. Events that change the story as we know it. 

We like patterns. They are the heart of the stories we tell ourselves. We create narrative arcs to protect us from storms, and make sense. 

Tyler Vignen’s “Spurious Correlations” where we see the number of shark attacks and Nicholas Cage movies have a similar chart... and so Nicholas Cage must cause shark attacks? 

If you do spin a coin, and record the genuinely random results... most people will see a pattern and say it isn’t random. Real randomness has long periods where life just throws heads, heads, heads, heads, heads, heads. That can’t be random! It is. It is random. 

The world is not against you. And it’s alright.

Survival of the Flexible

Many of us like to think that there is our own version of something controlling everything, and that allows us to find comfort. I moved away from being religious, but I still had the idea that there was a bias to good. That gave me comfort partly because of the possibility that you can control stuff. 

Gradually, I started to get more comfort than that, from the idea of randomness. The simple driver that stuff happens because stuff happens. 

There are different types of randomness. Part of the complexity depends on the constraints. When you roll a dice, there are only 6 possible outcomes. For a coin, it is two. The Rubik’s cube is incredibly complex, with 43 quintillion (18 zeros) combinations. That is a finite... but mindbogglingly large number. By adding a layer of pattern recognition, you can still learn to create a sense of control. 

Another level of randomness is simply a pulse. The mere existence of life and change. It does not have to have intent other than a will to survive. To cope with change. That does not require insight into the future. If you have sufficient biodiversity, you can cope with most changes in an evolutionary sense. 

You just don’t know which of the survivors will be the strongest in hindsight. That depends on what happens. Even if you see the result, and played again, a different scenario would unfold. That is complexity that responds to flexibility rather than control. Reacting and adjusting. Survival of the flexible. 

Create excess control and single solutions create the unintended consequences of mono-culture. Where we do not know that what we are doing is horribly wrong, until it is too late.

Rabbit Hunting

I played a lot of poker when I was at university and the early stages of work. Poker has a thing called “Rabbit Hunting”. When someone makes the decision to fold, but they ask the dealer to show what the next card “would have been”. It is irrelevant. If it is truly random, you didn’t know the rabbit when you folded. All the cards still in the deck, that you haven’t seen already, could be that card. Your decision has to be made in the light of uncertainty. The world we are in is not a single safe path. There are multiple ways things can play out. You need to be able to take account of all those paths, including in how you judge yourself. Don’t judge yourself purely on how things played out. How they could have played out is just as important a part of the learning process. A decision can still be a bad decision, even if the result was good. Which is not the way that we tend to think. Success carries far less information, and far more danger, than failure. 

Turning on the Tom Tom

Autonomy suggests individual decision making. If it is abstract (controlled and theoretical), it works very well. In reality, our decisions impact each other in complex, ambiguous, and random ways. How do you handle joint decisions when a path is shared? Tom-Toms are one form of GPS. My wife’s name is Gemma John. We were once driving through an area in Fulham across the river from where I lived in Putney. The GPS was telling us to go one way but Gem was pretty sure we should go another way. So I turned off the Tom-Tom and listened to the Gemma John. Even in an area I knew reasonably well, I had got to the point where I had to decide whether the GPS was doing a better job than me (when in doubt), and whether to trust it or not. At what point do you delegate your decision making when you are in an area you do not understand? Or when someone (or something) can make better decisions than you, even if you believe you have a decent understanding? 

 

Risk Tolerance

Financial Planning starts with a conversation about you and your relationship with money. The goal being to understand your risk tolerance. If you want to still the waves of money anxiety, you are building your capacity to deal with complexity, randomness, and ambiguity. We do not, and cannot, have a complete understanding of cause and effect. We cannot know in advance what the result will be for each path we pick. If we did, we would all just pick the one that took us to our intended destination. The rules are always changing. You cannot just do exactly what has been done in the past, and expect the same result. A good conversation about financial planning starts with understanding you as a person, how you see money, what your goals are, and what you value. You do not get paid for taking risk. You get paid for adding value in monetizable areas others have signaled is in short supply. Risk tolerance is mainly your ability to adapt, adjust, and accommodate. Like physical strength and flexibility, risk tolerance is something you can build through exercise. Then you make money, or your money makes money, by solving problems for decision makers with money.

The Power of Grayskull

Risk is not just the chance that something will go wrong. The study of risk goes wider than that. Looking at the complexity, ambiguity, and randomness of the world and asking whether within that, “is there anything that we can rely on?” When you look at an individual instance of something, it is a bit of a roll of the dice. At least with dice, while there is uncertainty, there can only be six clearly defined outcomes. With a coin, there can only be two outcomes. If it is a fair dice, and you roll it enough times there will be roughly the same number of ones, twos, threes, fours, fives, and sixes. If a coin is fair, toss it enough times they will be roughly half tails and half heads. It is not merit that drives victory. Actuarial Science is partly the study of, and attempt to weather the storms of, the underlying distribution rather than the specific result. The distribution is the variety of outcomes that are possible. Alternative histories. A form of “there, but for the grace of God, go I”. What happens if we pool risk, and stop taking full credit for everything that goes well or badly? What happens if we admit that we are not Masters of the Universe?

Creating Calm

“Past performance is used as a guide only. It is no guarantee of future returns. Your investment can go up and down and you may not get back the full amount invested.” This is the standard disclaimer that all asset managers are obliged to make part of the conversation. Investments can, and do, double, triple, quadruple, or go to zero. There is so much noise, and difference between daily, monthly, and annual returns that it bears little resemblance to a salary. Even though your money is working. A salary is more analogous to a dividend. A dividend gets declared. Management aim to smoothly pay for the use of Capital. Aim to increase it each year. To pay it sustainably. They consider the strength of the capital to endure, and the ability of the business to adjust. The challenge is looking for the signal in the noise. Creating the ability to cope with the noise. Creating calm in a continuous storm.

Securing your Basket

Choices are made in baskets. Once one is made, the set of options changes. There are both intended and unintended consequences. To explore, Economists simplify this pesky problem with an assumption. “Ceteris Paribus” meaning with other conditions remaining the same. All else equal. The world is complicated, ambiguous, and random. We see only a slice of it, and we see based on how we have seen before. We see only what is meaningful to us. We see only when we notice the change/contrast. We have limits. Our worlds bump into each other, and in the past we lived in bubbles with shared baskets and constraints. Now it is difficult to navigate the lack of shared context that stands in the way of staying in touch with other worlds. Our messages to each other arrive as foreigners. We are constantly unpacking and unpicking. Through the chaos, a foundation becomes more essential. A base. Secure space to retreat to and to advance from. Where conditions remain the same.

Plan for Being Wrong

This Covid crisis was not a Black Swan. A Black Swan is something that has never been seen before, and all the evidence has been in the other direction. Every White Swan increases the conviction that all Swans are white. All the evidence confirms a belief that is fundamentally wrong. There have been pandemics before, and there were plenty of people talking about it before 2019. Hans Rosling’s book “Factfulness” (2018) listed Pandemic as one of the 5 big risks the world faces, along with Poverty, Financial Meltdown, Climate Change and World War. Financial Meltdown, Poverty, Climate Change and War are not Back Swans either. Read the book “The Black Swan” by Nassim Taleb. By definition, you can’t predict a Black Swan. You can predict that there will be Black Swans that upend our world view. You can build shock absorbers and plan for the fact that things will not go according to plan. A more important question than “Am I right?” is “what are the consequences if I am wrong?”. Plan for being wrong. Plan for adjusting the way you see the world as you engage with it.

Buying a Slice

Passive Investing involves fewer buying and selling decisions, and often results in an investor buying an index fund. The theory of passive investing suggests an efficient market. This means all available, relevant, information is included in the price. There is therefore no way to “beat” the index’s performance (other than by chance) because there is no mismatch between value and price (no bargains on offer). An index is a “basket of everything”. Except there is no market for “everything you can buy”, and there is no index tracking “a slice of everything”. You still need to actively choose an index, then take a view on that market’s efficiency. Fewer decisions lowers the costs. I agree. But my approach is more “Wu Wei”. Action through inaction. Make as few decisions as possible, but don’t buy something just because it is there. I believe in Fundamental Investing. Not buying something just because it is a bargain. Buying a slice of a real business because I understand what it does. I have a sense of its sustainability (because compounding matters). A sense of its resilience (because the world is unpredictable). Investment is about solving real problems in the real world. Consistently and creatively getting stuff done.

Endless Knot

Actions have consequences. Some are intended. Intention and incentives matter, but the world is so complicated (and getting more so) that we don’t, and can’t, have a strong grasp on cause and effect. The stories we layer on the world are glitchy and built on our own personal faulty understanding. Then thrown into the mix is a double helping of randomness that tends to swamp our efforts. The only thing you can truly plan for is that things won’t go according to plan. Build in a feedback loop. A little lesson from each step. Realise that each step taken changes the world. The lesson you learnt applies to a world that no longer exist. And is only relevant to one of the ways that world could have played out. Complicated. Ambiguous. Random. In a way that is empowering. No one understands. Don’t expect yourself to. The main goal is to create an environment that gives you time. Then the ability to adapt, adjust, and accommodate. Then create. Do something meaningful to you. Build. Learn. Rebuild. Every day.

Build to Build

I don’t agree that there is a trade-off between risk and return. You don’t make money by taking risks (unless you are an Insurance Company). Risk management is simply an acknowledgement that the world is complicated, ambiguous, and random. The future is surprising. Investment Returns come, not from being able to predict the future, but from creating value over long periods of time. You create value through the application of skills and knowledge. Uncertainty means it isn’t 100% clear what skills and knowledge you need to develop, and what problems will need to be solved. I like knowing my effort won’t go to waste. I don’t mind working hard. I do mind working pointlessly. I prefer evidence to faith, unless the process itself is something I am okay with. If the value is the process. Otherwise, I want to see the value first. Understand what needs doing. Why it works. What I need to learn to do it. The world changes, but there is a lot of evidence of skills and knowledge that add value. Build those for yourself, so you can build for others.

"The Sower" Vincent Van Gogh

Slow Down

I am a slow learner. Always have been. I started walking late. My Mother says that is because my older brothers carried me everywhere. I started talking late. Maybe I can blame my brothers for that too. It’s nice having someone to blame. When I was 7 years old, I was put in a Speech & Drama class for people who were struggling with school. When I was 9, I got a teacher who suddenly got me. Mrs Rae changed my course. As the foundations set in, things started making sense. I have never been afraid of looking like a Moron. Of asking the dumb questions. Of appearing to try too hard. I regularly get lost in the grass of things I don’t understand, think aloud, and make mistakes in public. We live in a world that rewards false confidence. That thinks those who understand cause and effect are worth putting in charge. The truth, I think, is that no one knows. We are all lost in the grass. The world changes too fast to understand. There is too much noise, and we see whatever we are looking for. The best we can do is choose what we pay attention to. What we give relevance to. What we build meaning from. Slowly.

Revert to Mean

Reversion to Mean is the reliable default assumption that you should take “this changes everything” with a pinch of salt. Habits run deep. Normal changes slowly. Normally. The hardest part of a fast is breaking the fast, gradually returning to more sustainable behaviour while maintaining the essence of the changes you took to an extreme. The danger is that big changes lie in the tails. The Fat Tails. Thinking the world can be neatly summarised into Risk and Return numbers that drive your decisions is like learning to drive on a farm, or learning to shoot fish in a barrel. Reversion to Mean works well enough that it is a Hubris factory. It can build track records of success that turn men into demi-gods. Till the day you realise the world is too complicated, ambiguous, and random to control. Till you realise you are not a God, and the best everyone can do is do their best. Till you personally, revert to mean.

Beware the Extremes

NeverEnding Story

Bottom-up Stock Picking is equivalent to seeing people as individuals and communities rather than abstract prejudices. It’s easier to simplify people and businesses into races, nations, and asset classes. It’s lazy. A bottom-up stock picker has a universe of thousands of public businesses from around the world to choose from. For most, you can afford to put them in the “Too Hard Pile”. You don’t have to have an opinion on everything, and you can admit ignorance on the vast majority of hard questions. You can gradually build an opinion on the endurance, resilience, and creativity of enough businesses to allow a margin of error. The first question is always, “what if I am wrong?”. Fundamental Investing isn’t about predicting the future. It is about creating an environment for sustainable growth in a world that is complex, ambiguous, and random. The key is time. You buy yourself time through consistent investing in strength, flexibility, and control. The peaks and troughs become the inevitable and predictable chapters in a much longer story of staying alive, and making a contribution to the conversation.

Yeeeaaah!

Wafer Thin

“The market can stay irrational longer than you can stay solvent” warned John Maynard Keynes. “When there is nothing particularly clever to do, the potential pitfall lies in insisting on being clever” adds Howard Marks. I am a big believer that the Emperor is wearing no clothes in many parts of the investment industry. The world is ambiguous, complex, and random. We seek out heroes who ooze confidence that is unwarranted. Many investors names are made or destroyed on a handful of decisions. Either these buy a decade or two (a career) because of something going well, or they have a failure carved into their souls. Extreme success may mean 60% of their decisions are right. A coin gets 50%. The margins are wafer thin. So regularly remembering that investing is more like dieting and exercising than a “how smart are you” contest is important. Everyone eats. Everyone moves. Make sure you are one of the people building towards something, rather than against someone.

Red Queen

“Survival of the Fittest” suggests a level of knowledge in advance. This is hindsight bias. Normally there is a base level of fitness, and then it is just those who have the specific survival skill required for the randomly selected sorting event. The world is complex, ambiguous, and random. We can work on our base fitness. We can be prepared for a variety of sorting events. If something happens that 95% wipes you out, you want to be in a position to rebuild from that 5%. “The Red Queen” principle in Biology is that evolution is more about running just to stay in the same place, “organisms must constantly adapt, evolve, and proliferate in order to survive while pitted against ever-evolving opposing organisms in a constantly changing environment.”

Being Wrong

In “Being Wrong”, Kathryn Schulz makes the point that we don’t know what it feels like to be wrong. Once we gain the information that makes us genuinely realise we were wrong, we are instantly in a different state. Resilience requires allowing for our perpetual ignorance. Daniel Kahneman highlights the challenge we face because of our desire to seek out patterns, “the idea that the future is unpredictable is undermined every day by the ease with which the past is explained.” We think that once we have information, we could have done better if we rewound, and play was pressed again. The world is random. Just pressing play again would change the result. Like throwing a dice again armed with a time machine, knowing a dice was a four last time still wouldn’t be helpful. Each mistake arms us to avoid that mistake in the future, only if the future plays out in exactly the same way. According to a fixed script. What Kahneman highlights is that the correct lesson when you make a mistake because you didn’t anticipate something is that “the world is difficult to anticipate”. You will be wrong. You will make mistakes. Resilience is about building the capacity to survive and thrive despite the certainty of uncertainty.

Risk and Return

You don’t get paid for taking risk. The idea that you can simplify risk into a single number is wrong. This means you can’t simply choose a higher return because you have a higher risk tolerance. You can get return-free risk more easily than risk-free return. The best you can do with risk is manage it. Through mitigation, avoidance, transfer, or acceptance. In the long run, the return follows the fundamentals. What is being done? What is being made? What problem is being solved? Is someone willing to pay for it, and can you create a container through which you can charge? The world is complicated, ambiguous, and random. The best we can do is build endurance and resilience. Then do something valuable.

Volatility isn't Risk, Smooth isn't Safe

The Fittest

Survival of the fittest suggests a level of knowledge in advance. In reality, we tend to have a survival bias. Those that make it through fit stories to explain why they were the winners. If history had played out differently, the alternative story would have fit equally snuggly. We are chronic pattern seekers and can add a layer of meaning onto any random jumble of stars. Advance “Fitness” is more about developing resilience. The ability to sustain knocks in a variety of situations. Ensuring everything you do has an underlying quality, but accepting that the noise of life will have the loudest voice. Resilience helps you be part of the editing committee as your story is written.

Orion