Conscious Justification: Do We Have Free Will or Free Not?

There has been a rigorous debate for the last 2000 years dating back to the Platonic ages pertaining to free will, consciousness and decision-making. Have you ever asked yourself when making decisions, what are the influences of the decisions? Do I have free will? Is the outcome already determined?

It is beneficial for us as conscious creatures to try to understand the dynamics of the decision-making process and the process the brain uses. I would like to individually examine some of the crucial factors of the decision making process. We can call it the mental model of metacognition, or thinking about how we think.

 The first factor of the decision making process I would like to examine is justificationJustification was chosen first because it is our personal perception of why we made the choice, whether known or not beforehand.

“I think therefore I am” - Rene Descartes

A little contextual backdrop

Our minds work in a hierarchical and linear fashion as a result of billions of neurons and trillions of connections simultaneously firing, strengthening synaptic connections through continuous electrochemical reactions, or as the old saying goes “neurons that wire together, fire together.”

If the electrochemical threshold is not met between synapses, the neuron does not fire. The complexity of the microscopic process is distilled into a simple probabilistically determined answer, with a personal narrative interwoven by our neocortex. The neocortex is the wrinkled and folded external portion of our brain. The probabilities are determined like a hidden Markov model or Bayesian network of prior, conditional, joint and revised probabilities that we can only begin to understand.

Consciousness is defined by Oxford dictionary as:

 “The state of being aware of and responsive to one’s surroundings”

Consciousness cannot be distilled into simple language, as we do not have the words available to describe it in our vocabulary. Think of how you would describe through speech or writing the experience of salty, clear ocean waves splashing rhythmically into your chest. Language, whether written or spoken does not compensate experiencing the waves. For simplicity let us think of unconsciousness/consciousness as perception. Perception is not always deliberate or remembered, like how one perceives their procedural morning commute or what they ate last Tuesday for lunch.


Now that we have some background information let us start with a mind experiment of choice and justification.

Look at the two pictures below and think about which one you prefer. Before you choose, think about why you prefer that particular picture.

Picture 1 [Abstract Lines]

Picture 2 [House in the Forest]

So which picture did you prefer? Why?

The majority of respondents will have said picture two because of the prime that was used, asking you to justify your choice. In the original experiment, the control group that was not asked to justify their choice usually chose the abstract painting of the colored lines. Only when the group was asked prior to choosing to justify their response was the picture of the forest chosen.

Prior justification single handily changed the outcome.

Now what if you were told it is harder to make a choice without justification and then went a little further, explaining that the majority of people will actually pay money to postpone the decision if there is not justification for it to be made?

Well that is exactly what Tversky and Shafir did in 1992 with the following experiment.

Imagine that you have just taken a tough qualifiying examination. It is the end of the semester, you feel tired and run-down, and you find out that [(pass group) you passed the exam; (fail group) you failed the exam and will have to take it again in a couple of months – after Christmas holidays]. You now have the opportunity to buy a very attractive 5-day Christmas vacation package to Hawaii at an exceptionally low price. The special offer expires tomorrow. Would you

  • Buy the vacation package?
  • Not buy the vacation package?
  • Pay a $5 nonrefundable fee in order to retain the right to buy the vacation package at the same exceptionally low price the day after tomorrow?

    Passed Failed Result in 2 Days
Buy   54% 57% 32%

Don’t Buy

  16 12 7%

Pay $5 to Keep Option

30 31 61%

The interesting results to note are in the column “result in 2 days” as those students were told they would not receive their exam marks for two more days. Almost two thirds of students could not make the decision without their exam mark, opting to pay $5 to retain the option until they could justify making the decision.

Tversky and Shafir suggest that students who passed reward themselves for passing while students who failed use the trip as recuperation. There are other interpellations one could arrive at from the results but it does provide some intrinsic evidence that justification if a factor in the decision making process.

Why Does It Matter and What Can We Do?

 Our brains our naturally hardwired to be lazy, pursue the road of least resistance (availability bias) and think in linear hierarchies in fractions of a second. The confluence of factors leads to heuristics and mental short cuts, some of which are very helpful, others inhibit rational thought and action. Unfortunately there is likely nothing we can do as the process begins before we are even aware of it, deep inside the unconscious controlled by constantly changing implicit and procedural algorithms.

Vilayanur Subramanian “Rama” Ramachandran explains the situation differently stating there is always a lot going on inside of our minds and that we are consciously aware of very little of it. Decisions of all magnitudes are continuously being processed with proposed solutions arriving at our consciousness. Rama suggests instead of focusing on “free will” of the decisions, we should focus on “free won’t” – the power to reject solutions proposed by our unconscious.

Consider the analogy (borrowed from Ray Kurzweil) of a military campaign. Army officials prepare a recommendation to the president. Prior to receiving the president’s approval, they preform prep work that will enable the president to make the decision. The proposed decision is presented to the president who approves it or disproves it. If the decision is approved the mission is undertaken.

We can argue how much or how little influence is exerted on the president but the structure of the analogy remains the same, the decision making process begins (and is usually presented) before we become consciously aware of it.

As investors let us think about the justification prior to making the decision and to attempt to inhibit the profound availability bias. Do not settle for surface justification but rather look for the structural ones and above all, never be afraid to answer:

I… Don’t … know.

The Brain – is wider than the Sky –

For – put them side by side –

The one the other will contain

With ease – and You – beside –

The Brain is deeper than the sea –

For – hold them – Blue to Blue –

The one the other will absorb –

As Sponges – Buckets – do –

The Brain is just the weight of God –

For – Heft them – Pound for Pound –

And they will differ – if they do –

As Syllable from Sound

- Emily Dickinson

A Diamond In The Rough: Warren Buffett Talks Jewellery

Warren Buffett (TradesPortfolio) detailed in a written letter what you should know about the business economics of the jewelry industry in general and specifically Borsheim’s. The letter was written shortly after the acquisition was made in 1989. Emphasis is my own with additional comments added throughout original excerpts. 

First WB explains very simply the economics of the existing jewelry industry.

1) high overhead

2) average margins

3) high fixed costs.

The high overhead is based on low inventory turns, a small majority (25-30%) likely coming from inventory holding costs, insurance and shrink. Another direct result of low inventory turns is the amount of capital that is “tied-up” in working capital, essentially diluting returns on capital as it sits idle in inventory.

 To begin with, all jewelers turn their inventory very slowly, and that ties up a lot of capital. A once-a-year turn is par for the course. The reason is simple: People buy jewelry infrequently, and when they do, they are making both a major and very individual purchase. Therefore, they want to view a wide selection of pieces before zeroing in on a single item.

Given that their turnover is low, a jeweler must obtain a relatively wide profit margin on sales in order to achieve even a mediocre return on their investment. In this respect, the jewelry business is just the opposite of the grocery business, in which rapid turnover of inventory allows good returns on investment though profit margins are low.

In order to establish a selling price for their merchandise, a jeweler must add to the price they pay for that merchandise, both their operating costs and desired profit margin. Operating costs seldom run less than 40% of sales and often exceed that level. This fact requires most jewelers to price their merchandise at double its cost to them or even more.

The math is simple: Jewelers charge $1 for merchandise that has cost them 50 cents. Then, from their gross profit of 50 cents they typically pay 40 cents for operating costs, which leave 10 cents of pre-tax earnings for every $1 of sales. Taking into account the massive investment in inventory, the 10-cent profit is adequate but far from exciting.”

Now let us think…

If we were in charge of running the businesses and tossed in as the CEO tomorrow, whatchanges would we implement, what would we leave the same?


What would be the optimal strategy to pursue?

At first glance, we would likely come to the conclusion we need to turn our inventory quicker, we need lower fixed costs and we need higher gross margins. What we need is a higher capital turnover ratio. (Sales / Invested Capital)

But how can a higher capital turnover be achieved?

We need to either increase the numerator (Sales) or decrease the denominator (Invested Capital), or a combination of both.

“ At Borsheim’s the equation is far different from what I have just described. Because of oursingle location and the huge volume we generate, our operating expense ratio is usually around 20% of sales. As a percentage of sales, our rent costs alone are fully five points below those of our typical competitor. Therefore, we can, and do, price our goods far below the prices charged by other jewelers. In fact, if they priced to match us, they would operate at very substantial losses. Moreover, in a virtuous circle, our low prices generate ever-increasing sales, further driving down our expense ratio, which allows us to reduce prices still more.

How much difference does our cost advantage make? It varies by competitor but, by my calculation, what costs you $1,000 at Borsheim’s will, on average, cost you about $1,350 elsewhere. This is called the “Borsheim’s Price”. There are very few instances where we are unable to offer you those great savings due to restrictions, but you will always know upfront if an item is non-discountable.

Borsheim’s charges roughly 26% less for merchandise than competitors. They are enabled to do so because of the low fixed costs (rent, property tax, insurance etc.) and huge volume (higher inventory turns, lower overhead in the form of lower inventories on hand, lower variable costs due to scalability) created through direct selling.

 Our “shop-at-home” program brings Borsheim’s to our qualified customers. Simply contact Borsheim’s to describe what you’re looking for – to any degree of detail. We will assemble selections that best reflect your wishes and send them to you. Then, in the comfort of your own home or office, you can conveniently and leisurely select the item(s) you most prefer, or return the entire selection. Our results from this “shop-at-home” program have been amazing. Customers have loved it and keep coming back for more. Each year, we send out several thousand packages, ranging in value from $100 to $500,000.”

The business economics described above are not new and can be seen when examining Nebraska Furniture Mart (1983 acquisition) and the famous Dell business model that everyone seems to relate it to. Because of the single location, roughly 5% mark-up can be forgone by the product vendor and passed onto the consumer in the form of price savings. I like to call these feedback loops or cycles, “the ratchet up effect”, essentially leading to a virtuous cycle or prosperity for the low cost producer or leader. 

 I can remember well how helpless I used to feel in a Fifth Avenue or Rodeo Drive jewelry store, where the only thing I knew for sure was that the operator had extraordinarily high overhead – and that they had to cover it in their sales priceI was also wary of the “upstairs” solo operator who operated on consignment merchandise, since that would have cost them more than merchandise bought outright, and would necessarily haveinflated their retail price.”

Key Take Away

    • In a commodity business, high inventory turns are crucial


    • The lower the business overhead, the better


    • More units sold and spread across a smaller base of fixed costs results in a higher return on capital


    • Selling on consignment is not usually beneficial in a commodity type business


    • Direct selling reduces fixed costs and increases inventory turns, if done correctly


    • Capital turnover ratio signifies how much $1 invested can produce in revenue.


    • A cost advantage is a competitive advantage susceptible to “the ratchet up effect”


I will write up something in more detail later in the week regarding the cost of capital, the return on capital, growth and how they are all interrelated. Thinking deeply about capital invested and the return on that capital as well as their relationship to growth is something I would encourage all investors to do routinely. Look for reasons why the ROIC is above or below average (9% is the median according to “Valuation” by Mckinsey & Company) and how the advantage is created or lost. 

“Constantly think about how you could be doing things better and keep questioning yourself” – Elon Musk

Howard Marks Memo: Dare to be Great I & II

A new memo from Howard Marks is out and is it ever great. The original post “Dare to be Great” is provided here. I would definitely suggest reading both, preferably the one from 2006 first, as it serves as an appropriate backdrop on the context in which Marks writes today. Either way, Howard provides some key excerpts from 2006 in the 2nd part, published April 8th, 2014 and provided below.

In September 2006, I wrote a memo entitled Dare to Be Great, with suggestions on how institutional investors might approach the goal of achieving superior investment results. I’ve had some additional thoughts on the matter since then, meaning it’s time to return to it. Since fewer people were reading my memos in those days, I’m going to start off repeating a bit of its content and go on from there.

About a year ago, a sovereign wealth fund that’s an Oaktree client asked me to speak to their leadership group on the subject of what makes for a superior investing organization. I welcomed the opportunity. The first thing you have to do, I told them, is formulate an explicit investing creed. What do you believe in? What principles will underpin your process? The investing team and the people who review their performance have to be in agreement on questions like these:

  • Is the efficient market hypothesis relevant? Do efficient markets exist? Is it possible to “beat the market”? Which markets? To what extent?
  • Will you emphasize risk control or return maximization as the primary route to success (or do you think it’s possible to achieve both simultaneously)?
  • Will you put your faith in macro forecasts and adjust your portfolio based on what they say?
  • How do you think about risk? Is it volatility or the probability of permanent loss? Can it be predicted and quantified a priori? What’s the best way to manage it?
  •  How reliably do you believe a disciplined process will produce the desired results? That is, how do you view the question of determinism versus randomness?
  •  Most importantly for the purposes of this memo, how will you define success, and what risks will you take to achieve it? In short, in trying to be right, are you willing to bear the inescapable risk of being wrong?

    Passive investors, benchmark huggers and herd followers have a high probability of achieving average performance and little risk of falling far short. But in exchange for safety from being much below average, they surrender their chance of being much above average. All investors have to decide whether that’s okay. And, if not, what they’ll do about it.

    The more I think about it, the more angles I see in the title Dare to Be Great. Who wouldn’t dare to be great? No one. Everyone would love to have outstanding performance. The real question is whether you dare to do the things that are necessary in order to be great. Are you willing to be different, and are you willing to be wrong? In order to have a chance at great results, you have to be open to being both. 

    Dare to Be Different
    Here’s a line from Dare to Be Great: “This just in: you can’t take the same actions as

    everyone else and expect to outperform.” Simple, but still appropriate.

    For years I’ve posed the following riddle: Suppose I hire you as a portfolio manager and we agree you will get no compensation next year if your return is in the bottom nine deciles of the investor universe but $10 million if you’re in the top decile. What’s the first thing you have to do – the absolute prerequisite – in order to have a chance at the big money? No one has ever answered it right.

    The answer may not be obvious, but it’s imperative: you have to assemble a portfolio that’s different from those held by most other investors. If your portfolio looks like everyone else’s, you may do well, or you may do poorly, but you can’t do different. And being different is absolutely essential if you want a chance at being superior. In order to get into the top of the performance distribution, you have to escape from the crowd. There are many ways to try. They include being active in unusual market niches; buying things others haven’t found, don’t like or consider too risky to touch; avoiding market darlings that the crowd thinks can’t lose; engaging in contrarian cycle timing; and concentrating heavily in a small number of things you think will deliver exceptional performance.

    Dare to Be Great included the two-by-two matrix and paragraph below. Several people told me the matrix was helpful.

    Of course it’s not that easy and clear-cut, but I think that’s the general situation. If your behavior and that of your managers is conventional, you’re likely to get conventional results – either good or bad. Only if your behavior is unconventional is your performance likely to be unconventional . . . and only if your judgments are superior is your performance likely to be above average.

    Continue Reading 


Q&A with Michael Shearn of Compound Money Fund

Michael Shearn founded Time Value of Money, LP, a private investment firm, in 1996, to devote his attention to selecting and researching stocks and private investments. He launched the Compound Money Fund, LP, a concentrated value fund, in 2007. Shearn serves on the Investment Committee of Southwestern University, which oversees the school’s $250 million endowment. He is also a member of the Advisory Board for the University of Texas MBA Investment Fund.


Michael is the author of “Using an Investment Checklist: The Art of In-Depth Research.”


Question: Hey Micheal, it’s great to have the opportunity to ask you a few questions!

I have three, but they’re all on completely different topics so I’ll make them separate comments. First one:

With the subtitle of your book being “The art of in depth research” (purchased the Kindle version today by the way, can’t wait to read it!), and the reviews all confirming that your approach is pretty exhaustive, do you think it’s possible for the average every day guy to successfully pick stocks given very limited time to do research? This debate gets brought up very often here; how many hours would you say need to be devoted to researching a company before an idea can be turned into a good investment?


Answer: I personally believe it is difficult to do anything well in a limited amount of time. Although I will say if you can focus 2-3 hours a day on research without interruption (no email, phone calls, distractions) then you can closely match the time that most investment professionals spend on actual research – if not more. One of the dirty secrets of the investment management industry is that most investment professionals do not have time to research a lot of businesses because they have to spend their time building their business (money raising, client relations, operations, etc.) Therefore, if you can develop the habit of being able to focus on a daily basis on stock research then you will be quite surprised at your outcomes.

As far as how much time it takes to determine if something is a good investment or not this is difficult to answer because it varies by your experience level in investing and the number of mistakes you have made and more importantly your ability to learn from your mistakes. Therefore, the answer is that it depends on you and your experiences. The best investors have failed many times and have learned from these experiences so on the next investment they learn what to look for or more importantly what to avoid. For example, one of my first investments went bankrupt so I learned about the importance of avoiding highly leveraged businesses.

Question: Do you recommend that retail investors develop their own investment process or adopt one from a pro?

If an investor decides to create their own do you have any advice about how they should go about doing that?

Answer: I think you should learn as much as you can from the pros such as Warren Buffett because they can help you short-cut the process and more importantly you are in a position to better recognize and learn from an investment mistake. In other words, you need to learn the principles of making successful investments from the pros and then go out and apply them on your own. There is no better teacher than making your own mistakes but the key is to not waste them or let them get you down. The key is to learn from them.

As far as creating your own there is no thing as an original idea. In other words, no one can sit in a room and come up with an idea in a vacuum. They have to be constantly studying others in the industry who have had long-term success and try to extract the time-tested principles and lessons learned by those people. Where people go wrong is studying the wrong “pros” such as those who have recent success or in trying to copy others exactly the same way. The key is to formulate what works for you. For example, I used to copy other investors and looked at investing in distressed assets because I saw some pros were successful at this but frankly I did not enjoy this that much and never got very good at it. For me, learning about management teams is something I really enjoy and is the niche I have carved in the investment world. The big benefit to the investment world is that there are so many niches and methods to make money. The key is to learn which one you enjoy the most and then get busy learning as much as you can about it-whether it is qualitative or quantitative investing.


For each investment some questions on the checklist are more important to answer than others. For example, if a business has debt then it is critical for us to answer the questions on debt but if it has limited or no debt you can just ignore this question. The checklist is therefore meant to be flexible.


The strategy I have learned to use is to improve my ability to judge management teams. When you are investing for the long-term you have to be partnered with the right people because if not time works against you instead of for you. I would say spend some time learning how to identify great management teams. A great starter is the book by Robert Miles “Warren Buffett CEO” because it profiles many of the different CEOs that run the subsidiaries of Berkshire Hathaway.


They are all in completely different industries yet they share many of the same qualities and characteristics. Another book is Sam Walton’s autobiography Made in America which I think is terrific in helping you understand what are the qualities inherent to a great manager. I would then study what makes a bad manager by reading a book such as Bethany McLean “Smartest Guys in the Room” so you can learn who to avoid and what are the characteristics of these managers.


Question: What was your experience running a fund, and how does that contrast to what you’re doing with Southwestern? Do you think that endowment management or something similar could be a decent alternative to hedge funds for someone who is really passionate about the industry?


Answer: Endowment management is focused more on picking asset classes or investment firms rather than picking individual stocks so it is a different skill set. I believe you have to choose one or the other.

As far as your first question I would start off by saying that you are lucky to have found your passion in life (not many people do). Second, you have identified what you don’t want (a firm that does not value work/life) so you can now more quickly determine whether an investment firm meets your criteria or not.

I would personally avoid those firms that do not value work/social life balance (i.e.most hedge fund firms in New York). Investing is a long game and you never want to be burned out or be at a firm that is more interested in how much you work rather than the quality of your research. I personally believe it is critical to have balance and the opportunity to step back and see the big picture in investing. The best investors spend a lot of time analyzing an investment but then step back on the investment for a couple of weeks to get perspective on all of their prior work. It is an iterative process and having balance in life helps you be more productive.


The key is to constantly uncover rocks and keep looking. I had an intern once who said that he wanted to travel to third-world countries to look for investments and he dedicated a lot of time to identifying all of the investment firms that specialized in emerging markets. He then looked for articles on these firms to understand what their investment approach was and looked at their historical investments. He would then call the manager with the benefit of knowing a lot about the firm and ask them more pointed questions on how they applied their investment methodology of investing in emerging markets and asked if he could be of value to them. He eventually got the job he was looking for so yes, it can be done but like anything in life it requires a lot of legwork. Good luck on this endeavor!


Question: What is your opinion of the overall usefulness of “Wall Street” and the investment management industry? Of course people always trot out the “more efficient allocation of capital” argument, but do you think that Wall Street is really benefiting the economy as much as they are taking away from it by using up talented engineers and physicists and statisticians or screwing people on shady CDO deals and all that?


Answer: I agree with your premise that the investment management industry as a whole does not create a lot of value and that it mainly serves the personal interests of those who manage the money. As a mentor once told me “the money is not made in New York, it is sent to New York where it is chopped up in fees”. That being said this argument can be applied to any industry or profession. In my opinion there are always a limited number of shining stars in any given profession or industry. For example, in physics Richard Feynman is a great star but there are many examples of physicists who are only interested in getting published or being lauded by their peers instead of creating new and valuable ideas. On the whole though your argument is extremely valid for Wall Street in particular. I don’t know if I could argue that it is taking away talent from other professions because those who enter Wall Street tend to be more interested in making money so I don’t know if Einstein would be taking a job on Wall Street because his interest was always more on ideas than in making money. I am still in the process of formulating this opinion though…


Question: We’ve had a big debate around here recently regarding high frequency trading. Do you have any thoughts on the matter?


Answer: I believe it is the next big shoe to drop (i.e. scandal) in the securities industry. If you look at the total fees spent on buying and selling securities on all exchanges 10 years ago such as the NYSE, NASDAQ it was in the $2-3 billion range but with the advent in high frequency trading this amount has been multiplied by 10 times so it therefore is more expensive to buy and sell securities today than it was in the past because these high frequency trading firms are front-loading most transactions. Mutual funds and other institutions have been complaining about the increased cost for some time and prosecutors are finally starting to listen so there will definitely be more regulation in the future in this area.


Question: What books have been most influential for you in your career? Are there any that you’d recommend that may have flown under my radar (i.e. something outside the typical “Intelligent Investor”, “One Up On Wall Street”, “Margin of Safety” classics)?


Answer: I recommend the book Antifragile by Nassim Taleb because if you can adopt the mind frame of always looking for optionality in your investments then you will put the odds of investment success in your favor. What I mean by optionality is that if you invest in a highly leveraged firm then the future outlook for a business is more narrow because the management team is often forced to make short-term decisions that are detrimental to the long-term health of a business.


The reason for this is that the high debt does not give them many options on what they can do. Think about how a management team would not be able to commit to losing money on research and development on an important project that could be profitable 3 years from now because they must instead focus on making interest and principal payments on the debt. What I like about the book is that it helps you adopt this mental framework in investing of always looking for businesses that have lots of optionality which are businesses that will not be severely impacted by things such as downturns in the economy or black swans.


Question: Could you give us a brief overview of your checklist? Is it a list of yes or no questions, or metrics, or what?


Answer: The questions help guide you on deepening your understanding of a business and its management team. The key to investing in anything is having an understanding of what the future cash flows of the investment will be. The only way to do this is to examine a business from a variety of perspectives. You want to know if a business has some type of competitive advantage that protects its cash flows or whether it is one that a competitor can easily come in and under price them. Sometimes, you have a great business but if the management team is not good then the cash flows will not grow.


Witness how both Coke and Microsoft which are great businesses have not created much value over the last decade or so. Most of this is due to not having the proper management in place. So instead of being a yes or no response it is more of why do we believe the management team is competent or has integrity? Are the products good for customers and why? Is the CEO product (Steve Jobs at Apple) or sales (Balmer at Microsoft) focused? If the business disappeared tomorrow what impact would this have on the customer base? The questions help you understand the stability of cash flows today and how they are likely to change in the future.


Sometimes, the questions help you understand that you really don’t understand an investment and therefore should avoid it or they can help you understand what areas you need to further research by those questions you are not able to easily answer. This often can tell you the potential risks you face in an investment.


Question: What would be the sub-categories on your investment checklist? Currently on my own I have:

1) Risks 2) Costs and Cost Structure 3) Units (Capacity, Elasticity, SSS, Volume, Pricing power etc.) 4) Management/Insiders 5) Balance Sheet 6) Competition 7) Income Statement 8) Compensation 9) Cash Flow 10) Products/Services (Switching Costs, revenue mix, reoccurring etc.)

all with about 5-10 more specific questions below for a total of about 85 questions. Is this too much?

I am not sure If I am missing any big themes and would love to hear your opinion.

The 2nd question being at what age did you “break into” the industry and what would you recommend someone wishing to create a partnership should do if they are under the age of 30. Is the CFA an ideal achievement?

The 3rd question being, what would be the first 3 questions you ask yourself in terms of your investment checklist?


Answer: No – it is not too many questions because you will not have to answer all 85 questions in each investment that you make. For example, if a company has no debt you can ignore 5) balance sheet but if it is a business with a high fixed cost base then you have to pay attention to 1) Risks, 2) Costs and Cost Structure way more than the others. You weigh the questions for each particular investment you make and also for your experience level. When I first started it was important for me to ask more questions because I was learning more about investing but as I made investment mistakes and my judgement was being formed I learned what questions were more important to ask for a particular investment (which is a process that is always ongoing). The list should be comprehensive because it brings certain things top of mind and makes sure that you are not forgetting to ask what could be a very important question or you can learn what you don’t know by the questions you are unable to easily answer.


As to your 2nd question I broke in right after college because I frankly could not get a job at an investment management firm because I did not have any distinguishing background that would pique their interests. I later learned that when I applied to New York firms that these firms were looking more for pedigree (what school I went to) and since I went to a small liberal arts school in Texas with limited name recognition in New York I did not stand out in any way so I started doing analyst research work for an individual investor basically for peanuts but I was doing what I enjoyed. As far as forming a partnership you need to determine how many people will invest with you in your close circuit such as friends and family because it will be extremely difficult to get outsiders to trust you so you have to focus on those who already trust you first. I don’t believe the CFA is an ideal achievement but if you are raising funds from institutions then it becomes a “must have” so depends on the type of investor base you are targeting.


The first three questions we ask is 1) If the business disappeared tomorrow, what impact would this have on the customer base? 2) What is the background of the CEO? Are they sales focused or product focused? and how did they rise in the organization 3) Is this a business that we would be interested in learning more about – in other words can we sustain interest learning about this business over a long period of time. For example, we avoid banks because I frankly am not interested in them and therefore will never be good at analyzing them. So the top questions are geared towards our investment style and what our criteria is for an investment which has been developed over time.


I remember when I first interviewed with firms that I was focused on selling myself. When I got to the other side (I was interviewing others to hire them) I realized how wrong I was. The key is to ask the interviewer questions to determine if the firm is one where you can add value. I remember interviewing one applicant who kept asking me specific questions on how we did things and then commented on whether he thought he could add value to our process. This made the candidate stand out from all of the other people who were focused on selling themselves.


When you don’t have pedigree you need to have something that demonstrates you can add value to a firm such as a thorough investment report on an investment that highlights how you think about investing and your process. Your investment does not have to be successful but it has to highlight your thinking. In other words, let the actions (your report) speak rather than words and then genuinely try to figure out if you can add value or if it is frankly a firm or people you would be interested in working for.


I would avoid firms where the HR department interviews you for a job instead of the person you will be working for. If you get an interview with the person you are potentially working for ask them what their expectations are of you and what you could bring to the table. What is it they are trying to accomplish by hiring you. Then be genuine about whether you fit this criteria and be honest if you don’t.


I have many examples where I told potential clients that I would not be a good fit for them and they ended up referring me to others who were so being authentic and not trying to fit the criteria of someone else is key. You will eventually self-select where you belong and if you lie about it or try to fit the criteria you will end up paying the price down the road. I hope this answers your question?

[Bonus] Michael Shearn on How Assess Company Management and Talks About Investment Checklists


How Has Kahneman’s Work Influenced Your Own?

It was Daniel Kahnemans 80th birthday last week and it was celebrated in style by Richard Thaler suggested that the question “How has Kahneman’s Work Influenced Your Own?” be asked to friends working in the fields of behavioural economics, psychology, cognitive psychology, law and medicine, a consistent stream of response has flown in.

“It is not just a celebration of Danny. It is a celebration of behavioural science”  - Richard Nisbett

(Kahneman is the author of Thinking Fast and Slow — if you have not read it, purchase a copy tomorrow and make some time to, you won’t regret it.) 

There were over 25 entries posted to and I will be honest, I did not read them all in detail. I am not familiar with most of the people commenting leading me to subjectively and prejudicially choose who was included and discluded. Provided below are comments from WSJ Journalist and author of Your Money and Your Brain, Jason Zweig, The author of Antifragile, Black Swan and Fooled By Randomness, Nassim Taleb and Harvard University’s Psychology Professor Steven Pinker. (Richard Thaler did not provided a comment under his section as of March 31st)


kahneman[Photo Credit: The Speculator] 


Jason Zweig: 

While I worked with Danny on a projectmany things amazed me about this man whom I had believed I already knew well: his inexhaustible mental energy, his complete comfort in saying “I don’t know,” his ability to wield a softly spoken “Why?” like the swipe of a giant halberd that could cleave overconfidence with a single blow.

But nothing amazed me more about Danny than his ability to detonate what we had just done.

Anyone who has ever collaborated with him tells a version of this story: You go to sleep feeling that Danny and you had done important and incontestably good work that day. You wake up at a normal human hour, grab breakfast, and open your email. To your consternation, you see a string of emails from Danny, beginning around 2:30 a.m. The subject lines commence in worry, turn darker, and end around 5 a.m. expressing complete doubt about the previous day’s work.

You send an email asking when he can talk; you assume Danny must be asleep after staying up all night trashing the chapter. Your cellphone rings a few seconds later. “I think I figured out the problem,” says Danny, sounding remarkably chipper. “What do you think of this approach instead?”

The next thing you know, he sends a version so utterly transformed that it is unrecognizable: It begins differently, it ends differently, it incorporates anecdotes and evidence you never would have thought of, it draws on research that you’ve never heard of. If the earlier version was close to gold, this one is hewn out of something like diamond: The raw materials have all changed, but the same ideas are somehow illuminated with a sharper shift of brilliance.

The first time this happened, I was thunderstruck. How did he do that? How could anybody do that? When I asked Danny how he could start again as if we had never written an earlier draft, he said the words I’ve never forgotten: “I have no sunk costs.”

To most people, rewriting is an act of cosmetology: You nip, you tuck, you slather on lipstick. To Danny, rewriting is an act of war: If something needs to be rewritten then it needs to be destroyed. The enemy in that war is yourself.

After decades of trying, I still hadn’t learned how to be a writer until I worked with Danny.

I no longer try to fix what I’ve just written if it doesn’t work. I try to destroy it instead— and start all over as if I had never written a word.

Danny taught me that you can never create something worth reading unless you are committed to the total destruction of everything that isn’t. He taught me to have no sunk costs.

Nassim Taleb:

The Problem of Multiple Counterfactuals

Here is an insight Danny K. triggered and changed the course of my work. I figured out a nontrivial problem in randomness and its underestimation a decade ago while reading the following sentence in a paper by Kahneman and Miller of 1986:

A spectator at a weight lifting event, for example, will find it easier to imagine the same athlete lifting a different weight than to keep the achievement constant and vary the athlete’s physique.

This idea of varying one side, not the other also applies to mental simulations of future (random) events, when people engage in projections of different counterfactuals (we treat alternative past and future histories in exactly the same analytical manner).

It hit me that the mathematical consequence is vastly more severe than it appears. Kahneman and colleagues focused on the bias that variable of choice is not random. But the paper set off in my mind the following realization: now what if we were to go one step beyond and perturbate both?

The response would be nonlinear. I had never considered the effect of such nonlinearity earlier nor seen it explicitly made in the literature on risk and counterfactuals. And you never encounter one single random variable in real life; there are many things moving together.

Increasing the number of random variables compounds the number of counterfactuals and causes more extremes—particularly in fat-tailed environments (i.e., Extremistan): imagine perturbating by producing a lot of scenarios and, in one of the scenarios, increasing the weights of the barbell and decreasing the bodyweight of the weightlifter.

This compounding would produce an extreme event of sorts. Extreme, or tail events (Black Swans) are therefore more likely to be produced when both variables are random, that is real life. Simple.

Now, in the real world we never face one variable without something else with it. In academic experiments, we do. This sets the serious difference between laboratory (or the casino’s “ludic” setup), and the difference between academia and real life. And such difference is, sort of, tractable.

I rushed to change a section for the 2003 printing of one of my books. Say you are the manager of a fertilizer plant. You try to issue various projections of the sales of your product—like the weights in the weightlifter’s story.

But you also need to keep in mind that there is a second variable to perturbate: what happens to the competition—you do not want them to be lucky, invent better products, or cheaper technologies. So not only you need to predict your fate (with errors) but also that of the competition (also with errors). And the variance from these errors add arithmetically when one focuses on differences. There was a serious error made by financial analysts.

When comparing strategy A and strategy B, people in finance compare the Sharpe ratio (that is, the mean divided by the standard deviation of a stream of returns) of A to the Sharpe ratio of B and look at the difference between the two. It is very different than the correct method of looking at the Sharpe ratio of the difference, A-B, which requires a full distribution.

Now, the bad news: the misunderstanding of the problem is general. Because scientists (not just financial analysts) use statistical methods blindly and mechanistically, like cooking recipes, they tend to make the mistake when consciously comparing two variables.

About a decade after I exposed the Sharpe ratio problem, Nieuwenhuis et al. in 2011 found that 50% of neuroscience papers (peer-reviewed in “prestigious journals”) that compared variables got it wrong, using the single variable methodology.

In theory, a comparison of two experimental effects requires a statistical test on their difference. In practice, this comparison is often based on an incorrect procedure involving two separate tests in which researchers conclude that effects differ when one effect is significant (P < 0.05) but the other is not (P > 0.05).

We reviewed 513 behavioral, systems and cognitive neuroscience articles in five top-ranking journals (Science, Nature, Nature Neuroscience, Neuronand The Journal of Neuroscience) and found that 78 used the correct procedure and 79 used the incorrect procedure. An additional analysis suggests that incorrect analyses of interactions are even more common in cellular and molecular neuroscience.

Sadly, ten years after I reported the problem to investment professionals; the mistake is still being made. Ten years from now, they will still be making the same mistake.

Now that was the mild problem. There is worse. We were discussing two variables. Now assume the entire environment is random, and you will see that standard analyses of future events are doomed to underestimate tails. In risk studies, a severe blindness to multivariate tails prevails.

The discussions on the systemic risks of genetically modified organisms (GMOs) by “experts” falls for such butchering of risk management, invoking some biological mechanism and missing on the properties of the joint distribution of tails.

Steven Pinker:

As many Edge readers know, my recent work has involved presenting copious data indicating that rates of violence have fallen over the years, decades, and centuries, including the number of annual deaths in war, terrorism, and homicide.

Most people find this claim incredible on the face of it. Why the discrepancy between data and belief? The answer comes right out of Danny’s work with Amos Tversky on the Availability Heuristic. People estimate the probability of an event by the ease of recovering vivid examples from memory. As I explained, “Scenes of carnage are more likely to be beamed into our homes and burned into our memories than footage of people dying of old age.

No matter how small the percentage of violent deaths may be, in absolute numbers there will always be enough of them to fill the evening news, so people’s impressions of violence will be disconnected from the actual proportions.”

The availability heuristic also explains a paradox in people’s perception of the risks of terrorism. The world was turned upside-down in response to the terrorist attacks on 9/11.

But putting aside the entirely hypothetical scenario of nuclear terrorism, even the worst terrorist attacks kill a trifling number of people compared to other causes of violent death such as war, genocide, and homicide, to say nothing of other risks of death. Terrorists know this, and draw disproportionate attention to their grievances by killing a relatively small number of innocent people in the most attention-getting ways they can think of.

Even the perceived probability of nuclear terrorism is almost certainly exaggerated by the imaginability of the scenario (predicted at various times to be near-certain by 1990, 2000, 2005, and 2010, and notoriously justifying the 2003 invasion of Iraq).

I did an internet survey which showed that people judge it more probable that “a nuclear bomb would be set off in the United States or Israel by a terrorist group that obtained it from Iran” than that “a nuclear bomb would be set off.” It’s an excellent example of Kahneman and Tversky’s Conjunction Fallacy, which they famously illustrated with the articulate activist Linda, who was judged more likely to be feminist bank teller than a bank teller.

If somebody were to ask me what are the most important contributions to human life from psychology, I would identify this work [by Kahneman & Tversky] as maybe number one, and certainly in the top two or three.

In fact, I would identify the work on reasoning as one of the most important things that we’ve learned about anywhere. When we were trying to identify what any educated person should know in the entire expanse of knowledge, I argued unsuccessfully that the work on human cognition and probabilistic reason should be up there as one of the first things any educated person should know.

Read the other comments on How Did Daniel Kahneman Influence Your Work ?