“What you really want to do in investments is figure out what is important and knowable. If it is unimportant and unknowable, you forget about it. What you talk about is important [macro factors] but, in my view, it is not knowable.” – Warren Buffett, in 1998
Can you live with a hole in the head? If that’s too dramatic, can you function with a void in the brain? This is a weird, important and inadequately discussed aspect of sound investing temperament.
Let’s do a thought experiment. Rewind to a panicky period, around when virus was thriving or Lehman was dying. You’re offered a wonderful business at a more than fair price (as a placeholder, let’s say TCS). Attractive industry, best-in-class company, excellent absolute and relative performance, superlative returns on capital, disciplined capital allocation via buybacks, bulletproof governance. You have a 95th percentile business available at 50th percentile valuation. Investment thesis complete. Only thing left is to place order with broker. Not so fast. Not so simple either. There are so many unanswered questions. How will panic affect US economy? In turn, demand for IT? Will contract signing or delivery suffer in new normal? Pricing pressure? Margins? Effect of shift to cloud or automation or whatever? Exchange rate? Will Biden raise taxes? Will Trump ban visas? We haven’t even got to Europe. In most cases, unanswered questions on unknowable issues won over a compelling thesis (why else was there a good deal in the first place).
I have written about ignoring pseudo experts who substitute confidence for knowledge. This is the easier part of acknowledging what’s unknowable. Most investors know, deep down, that columnists, economists, strategists and professors are bullshitters. It’s non-trivial to cut out this noise, but it’s doable. The far harder part has to do with the person in the mirror. To not get weighed down by unknowable factors, we need to make peace with not knowing. And that’s nearly impossible.
Many of us claim to ignore or downplay unknowable factors, especially since we have the backing of investing’s patron saints to do so. However, at a subconscious level, very few of us are truly indifferent about it. Accepting ignorance goes deeply against human nature. Our core learning OS is designed around spotting patterns (some non-existent), explaining them through stories (mostly fiction) and reinforcing them via confirmation and rationalization. It’s highly dissonant to not have any explanation whatsoever for the world around us. This mental void is unbearable.
Getting back to our example, we publicly admit that concerns pertain to unknowable external factors. We also acknowledge that best-in-class companies have a proven history of either overcoming such risks or managing them better than worse-run peers. However, saying so doesn’t imply acting so. Our subconscious beliefs overwhelm stated words. Deep down, we don’t treat ‘unknowables’ as unknown. We secretly fill up our discomforting void with theories, to minimize dissonance. We aren’t actually indifferent about exchange rates or macro outlook or nature of new normal. We harbour definitive beliefs, even if we don’t publicly express them since we can’t fully back them up or don’t want to appear more oracular than Buffett.
Unstated beliefs are doubly dangerous because we have to find an alternative justification. When we walk away from reasonable bargains saying “If only price was 20% lower”, the real reason is rarely valuation. It’s a fudge for having definitive views about unknowable factors without being able to express them. Subconsciously, we view everything as both knowable and known. Our cleverly hidden beliefs about rates or risks prevent action, but we use lower price as a cover. One giveaway is the notion of a moving target. When 20% lower is quickly reached amidst panic, suddenly it becomes “another 20% lower”. Another giveaway is setting an absurdly cheap price rather than a reasonably cheap one. Fundamental concerns about unknowable factors masquerade as pricing quibbles and get in the way of the whole greedy-fearful bit.
While there’s a lot of literature on knowing one’s limitations, circle of competence, too-tough bucket etc, I don’t think enough has been said on what it takes to practice these. They extract a psychological toll that takes a peculiar temperament to bear. Saying “I don’t know” is the easy part. Not caring about not knowing is the hard part. It’s more fundamental than merely feeling stupid or negligent. It goes against the grain of how we process the world around us, by admitting to ourselves that:
· I cannot make sense of what’s around me.
· It’s not for want of trying. In fact, I’m done trying.
· Yes, it’s discomforting as f&*k to have a void in my brain.
· No, I’m not filling it up with made-up s&*t just for false comfort.
· By the way, I’m going ahead with consequential actions despite my mental void.
In my experience, it’s rare to be able to genuinely make peace with ignorance. It’s an aspect of temperament that’s as valuable as it’s atypical. Acting with conviction amidst turmoil requires us to blank out large parts of what’s happening or may happen around us, so long as a few critical pieces are in order. And boy, do our buggy brains hate blanks. Like a hole in the head.