My views on the market, tech, and everything else

A Dozen Things I’ve Learned from Ben Carlson about Investing

Ben Carlson is one of my favorite finance writers. He is a CFA and has been managing institutional investment portfolios since 2005. He is both a writer and a teacher. His book on investing entitled A Wealth of Common Sense is out soon (you should pre-order it).

What I like best about Ben Carlson is that he is young and very savvy about not only investing but the tools of social and other forms of modern media like Twitter and Tumblr.  Too many of the people I write about who are able to teach others about investing are, well, either old or very old. People like  Ben Carlson, Patrick O’Shaughnessy, Morgan Housel, James Osborne and Josh Brown (the Magnificent Five) represent the next generation in financial writing. They are fearless in confronting financial advice poseurs of all kinds. That they all are moving swiftly into media formats like video makes me hopeful they can successfully combat more of the hucksters pushing “easy wealth in seven steps” style schemes. I am rooting for them, especially when they go after people like constantly self-promoting old coots flogging their financial flim-flams that hurt ordinary investors. The way they attack promoters of high sales loads and hidden fees with these new tools inspires me. When these Magnificent Five go after the “bad guys” I am always cheering  them on.


1. “The all-time great investors –Buffett, Marks, Dalio, Klarman, Munger and even Gundlach – have the ability to translate their ideas into simple terminology. Not only are they brilliant, but they all simplify their message when explaining their process.”

Teaching other people helps you think through your own ideas. If you can’t reduce your ideas and investing process to something you can describe simply to others, it is less likely that you have a sound investing process or at least your investing process is not as good as it might be. Teaching about investing has another benefit in that limited partners who understand your investing process are much more likely to stay with you when you are under-performing the market. Simply put, having investors who understand your investing process is a competitive advantage. Seth Klarman puts it this way: “At the worst possible moment, when your fund is down because cheap things have gotten cheaper, you need to have capital, to have clients who will actually love the phone call and – most of the time, if not all the time – add, rather than subtract, capital.” And finally, teaching others about investing is good for the teacher’s brand. A strong personal brand buffed to a shine via teaching makes raising money from limited partners easier.

2. “If you study Buffett, Marks, Soros, Lynch, Dalio, etc. you will find that even though their strategies differ, they all share the ability to control their emotions and make clear, probability-weighted investment decisions based on past experiences.”

The psychological aspects of investing are by far the biggest challenge for any investor. Getting control of yourself is a key part of getting control of your finances and investments. Humans will never stop making emotional mistakes. Focusing a significant portion of your time and energy on reducing those mistakes pays big dividends. On Ben Carlson’s second point Michael Mauboussin describes how to make wise, probability-weighted decisions: “Expected value is the weighted-average value for a distribution of possible outcomes. You calculate it by multiplying the payoff (i.e., stock price ) for a given outcome by the probability that the outcome materializes.”

If you can think probabilistically while controlling your emotions, investing gets far easier. Studying great investors helps with that learning process. Famous value investor Irving Kahn said once: “millions of people die every year of something they could cure themselves: lack of wisdom and lack of ability to control their impulses.”

3. “Everyone is conflicted in some way. It’s impossible to avoid conflicts of interest in the financial services industry. It is a business after all. The trick is to understand how incentives drive people’s actions and look for those firms and individuals that are up front and honest about any potential conflicts.”

The phrase “everyone is talking their book, all the time” has been seared in my brain ever since I heard it first from my friend Bill Gurley. It’s such a simple way to capture an important idea. An old German proverb says: “whose bread I eat, his song I sing.” And a lot of the time you are eating your own bread. Daniel Kahneman puts it this way: “Facts that threaten people’s livelihood and self-esteem — are simply not absorbed. The mind does not digest them.”  Warren Buffett advises people to beware of asking your barber if you need a haircut for that reason.

Buffett’s partner Charlie Munger said recently: “If the incentives are wrong, the behavior will be wrong. I guarantee it.”  That adds to what he said many years earlier: “I think I’ve been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I’ve always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.”
4. “It’s easy to be a long-term investor during a bull market. Everyone’s making money and it feels like you can do no wrong.  It’s when things don’t go as planned that this group loses control.”

People panic. Not only do they panic, but they follow other people who have panicked, who are following other people who have panicked [repeat]. Being in a “thundering herd” is most often not a good thing.  And to outperform the market you must leave the confines of the herd and be right about your reason for leaving. No one is ever contrarian as an investor “just in time” on a consistent basis. Contrarians must inevitably endure periods of underperformance and sometimes even ridicule from the herd.  Of course, being too early is often indistinguishable from being wrong.
5. “It’s not enough to say you will buy when fear is high and stock prices are low. You also have to have the necessary funds available to make purchases during times of maximum pessimism.”

Jason Zweig did a wonderful interview of Charlie Munger in which he wrote: “Successful investing, Mr. Munger told me, requires ‘this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don’t last very long.” Sitting on the sidelines in a rising market with cash earning just about nothing is a very hard thing to do. Lots of people may see a bargain during a downturn but may not have any dry powder at that time which allows them to act on that insight. Timing markets is folly, but having a long term attitude and only buying stock at prices that offer a margins of safety can help someone have cash available at a time like 2009.

6. “Understanding yourself and your own tendencies can be much more helpful to the investment process than knowing exactly what’s going on in the markets. You have no control over what’s going to happen in the markets, but you have complete control over your reactions to them.”

Most mistakes are psychological or emotional. Even Daniel Kahneman has said that after a lifetime of study of dysfunctional heuristics he still makes bonehead errors. Staying rational when making investment decisions is a life long struggle. You can never learn enough so that dysfunctional heuristics won’t potentially lead you to folly and error.

Everyone makes mistakes. The job of an investor is to make fewer new mistakes and to try to avoid being an idiot. Simply avoiding idiocy is highly underrated. My sister, a psychologist, said to me recently “what I think about in my practice is often not too different from what you write about on your blog.” This is of course true. Knowing yourself pays big dividends if you are an investor.

7. “Increased activity does not necessarily lead to better results.”

Investing by nature requires some activity. But not much. In other words, investing can never be completely passive. For example, you must allocate assets and chose an index fund/ETF if you are a passive investor. But there are aspects of investing where doing less through diversification improves performance since it decreases fees and lowers the adverse effects of performance chasing. As another example, an active investor who invests seldom but in a very aggressive way when the odds are substantially in their favor often experiences the best results. The market does not award prizes to investors who are hyperactive. Investors who are too concerned with always “doing something” are like horses wearing extra weight at a racetrack.

8. “All else equal, a talented sales staff will trump a talented investment staff when attracting capital from investors. There are organizations that can have both, but typically the firms with the best sales teams or tactics will end up bringing in the most money from investors. A well-thought-out narrative by an intelligent, experienced marketing department with the right pitch book can do wonders at persuading investors to hand over their hard-earned money. It’s difficult to admit we can be so easily persuaded but it’s true.”

Most investments are sold rather than purchased. Nothing else explains people still paying sales loads when purchasing an investment, when they are often easily avoided. There are people who can sell ice to Eskimos and many of them are selling investments. Howard Marks in a masterful recently published essay on liquidity skewers a few marketing strategies that are being foisted on people as an ‘investment free lunch’.

9. “Most investors will be immediately drawn to the marketing firms because people typically gravitate towards certainty, confidence and the latest fads.”

People love people who are confident. Daniel Kahneman writes: “Overconfident professionals sincerely believe they have expertise, act as experts and look like experts. You will have to struggle to remind yourself that they may be in the grip of an illusion.” You’ve seen these supremely confident motivational speakers make their pitch to investors saying things like “Just follow these seven steps and you will be rich.” It’s bullshit, but as long as it is presented confidently large numbers of sheep, err people, will follow.

10. “Financial models are fairly useless if you take them at face value. I dealt with extremely complex Excel spreadsheet models on a daily basis. They were a thing of beauty for spreadsheet geeks. Complex formulas and macros, linked data, pro-forma financial statements — all with the analysis spit out in a neat summary page. Every tiny piece of company and industry data was meticulously estimated or tracked down to the nearest decimal point. 

Many of the analysts I worked with told me it was their modelling skills that really set them apart from their peers.  But what I found from navigating these models is that there was always one or two levers you could pull that would completely change your output (price target or earnings estimate). A minor change to a discount rate or future growth rate assumption could drastically change the end result by a wide margin.”

When someone delivers you a spreadsheet and makes an argument based on that spreadsheet, I suggest to travel right to the assumptions.  This approach saves great amounts of time and wasted energy. Contrary to that old proverb, the devil is actually making trouble in the assumptions rather than in the details. There are also angels lurking in the assumptions too since a lot of innovation has its source changing a commonly believed assumption. Scott Adams could have just as easily been talking about spreadsheets rather than slides when he said: “If you just look at a page and drag things around and play with fonts, you think you’re a genius and you’re in full control of your world.” People who believe their projections that run six years into the future are accurate are as common as leaves in New England.

11.”Sometimes negative knowledge by learning what not to do is just as important as figuring out the right way to do something.”

Getting ahead by avoiding stupidity, particularly if the activity can potentially result in a big mistake, is such a simple idea. No one personifies this idea more than Charlie Munger. “I think part of the popularity of Berkshire Hathaway is that we look like people who have found a trick. It’s not brilliance. It’s just avoiding stupidity.” In learning what not to do, it is best if you learn through other people’s mistakes rather than your own. Avoiding stupidity is best done vicariously. There is no better way to see a lot of stupid behavior over a short time than reading.

You can learn so much just by watching people make mistakes in life, especially if you are genuinely paying attention. Charlie Munger’s ideas again come to mind: “Just avoid things like racing trains to the crossing, doing cocaine, etc.  Develop good mental habits…. A lot of success in life and business comes from knowing what you want to avoid: early death, a bad marriage, etc.” As I’ve said many times, it is best to avoid situations where you have a big downside and a small upside (negative optionality) and to seek the inverse (big upside small downside).

12. “The reason so many people don’t have their financial house in order is because they (a) become overwhelmed or (b) don’t care about finance because they find it boring.”

If you don’t find business interesting you should not be trying to outperform the markets. If actively investing in stocks is not about understanding individual businesses and business in general then exactly what is it about?  Most everyone should buy a diversified portfolio of low fee index funds/ETFs.  One trick that may help is to understand that business gets more interesting the more you learn about it. Once you get to critical mass in understanding basic principles, it all gets more interesting. Especially if you enjoy understanding how systems fit together and mutually reinforce each other, business can be very interesting. Andy Warhol said once: “Being good in business is the most fascinating kind of art. Making money is art and working is art and good business is the best art.”

But even then to be really good at understanding business and investing you must understand many disciplines. You must adopt what Charlie Munger calls a lattice of mental models approach. The best book on this is by Robert Hagstrom entitled: Investing: The Last Liberal Art.



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