What Do You Know That Everyone Else Doesn't

by Ben Carlson, A Wealth of Common Sense

ā€œIf you donā€™t have superior insight, how can something be to your advantage?ā€ ā€“ Howard Marks

Last week I had the chance to speakĀ to a group of finance students at Drexel University about my experiences in the investment industry. I tried to share with these students some of the things I wish I had been taught when I was in school.

One of the subjects I touched on was second level thinking. This is an important concept onĀ market expectations developed by Oaktreeā€™s Howard Marks. Marks explained this theory in detail in his book,Ā The Most Important Thing. Hereā€™s one of his examples:

First level thinking says, ā€œItā€™s a good company; letā€™s buy the stock.ā€

Second level thinking says, ā€œItā€™s a good company, but everyone thinks itā€™s a great company, and itā€™s not. So the stockā€™s overrated and overpriced; letā€™s sell.ā€

Following the talk, one of the students asked how to develop a second level thought process. I thought this was a great question, because a simple example doesnā€™t always tell the whole story.Ā This isnā€™t just something you can pick up from a book and master right away, if ever. Having a deep understanding of what is likely priced in and consistently making smart decisions based on that analysis is what puts Marks in the top 1% of investors. Itā€™s not easy.

But even if youā€™re unable to develop the same kind of second level mind that Marks has crafted over the years, you can still use this thought process to make yourself a better investor. Here are a few things I shared with this student on how to generally utilize second level thinking:

  • Always be willing to see both sides of every argument or investment stance you take. You have to be willing to actively seek out opinions that are different than your own. No one isĀ right all the time and thinking about where you could be wrong shows intellectually honesty and the self-awareness to know youā€™re not infallible.
  • Think in terms of probabilities, never certainties.
  • Donā€™t judge your decisions based on the outcomes; judge them by the process you took to make them.
  • Remember to think in terms of relatives, not absolutes.Ā Markets are all about expectations, especially over the short to intermediate term. Itā€™s not always about things getting better or worse, but less good or less bad. A misunderstanding of this concept has cost plenty of investors a lot of money over the past 5 or 6 years.
  • Be humble or the market will do it for you.
  • Always consider the difference between price and value. Any security or asset class can make for a good investment at one price and a poor one at another.
  • Never become too confident in your own abilities.

Very few investors are able to do what Howard Marks does. Everyone has to be willing to ask themselves:

  • Do I have insight into this investment that someone else doesnā€™t?
  • What is myĀ edge here?
  • What do IĀ know that the market doesnā€™t?

I concluded my talk with this student by telling her that you donā€™t have to have an opinion on everything thatā€™s going on in the markets, nor do you need to act on every impulse you get from the marketā€™s movements or your own research. I told her that I always start with the assumption that less is more. No one has all the answers and youā€™ll never be able to outsmart the markets at all times.

Source:
The Most Important Thing

Further Reading:
One of the Worst Arguments in Finance
A Lesson in Market Crashes

Copyright Ā© A Wealth of Common Sense

Total
0
Shares
Previous Article

Connecting the Dots

Next Article

On Embracing Stupid

Related Posts
Subscribe to AdvisorAnalyst.com notifications
Watch. Listen. Read. Raise your average.