Rules of thumb versus getting lost in details
I have a cynical theory: At least half of what we see in life is unnecessary complication masquerading as added value.
In the introduction to his book “23 Things They Don’t Teach You About Capitalism,” economist Ha-Joon Chang writes:
“I do not go into many of the technical details that even a basic introductory book on economics would be compelled to explain. However, this neglect of technical details is not because I believe them to be beyond my readers. Ninety-five percent of economics is common sense made complicated, and even for the remaining 5 percent, the essential reasoning, if not all the technical details, can be explained in plain terms.”
How refreshing. I wish we had more of this, because most of us intuitively know it’s true.
I had an economics professor in college who, on the first day of class, announced, “There will be no formulas, no math, no textbooks in this class. Chalkboards hurt my wrists.”
Instead, he began each class with, “Here’s what I read in the Wall Street Journal this morning,” and spent an hour discussing the historical context and details of the day’s top economic news, like how job numbers are calculated, or problems with trade deals. He used words and told stories. The examples were real, never hypothetical. Every class was like a documentary where you could interrupt the narrator and ask questions.
The professor admitted that he was looked down upon by his technically minded academic peers. But every classmate I talked to said they learned more from that class than any other. No one remembered a damn thing from calculus, yet they still talk about stories this professor told. That was the irony: What was viewed as cookie-cutter and too basic was doing a better job teaching students than the traditional model of banging back formulas. You don’t teach undergrad students about hyperinflation with a supply/demand model. They’ll forget everything. You tell them stories about Weimar and Zimbabwe. They’ll soak that up and remember it for life.
The best part was that all of the math — the technical details — was implicitly being taught in this professor’s stories. Nothing was being ignored or rebutted. Math is really important. He just simplified the complicated stuff into rules of thumb that were easy to communicate. Unless you’re going to teach finance, you probably don’t need to memorize the formula for, say, compound interest. “Money makes money, and that money provides more money to make more money,” gets the point across, and all of the math behind compound interest is still captured, even if the student doesn’t know the formula. Simplified rules of thumb don’t ignore technical details. They distill them into practical ideas and real-world context. In that sense, the technical details — not the rules of thumb — are often the incomplete, shorthand version of a theory. It’s a crazy paradox, but it’s so powerful.
After school I realized that this logic applies to more than teaching. It’s just as useful in investing.
Finance is a simple industry made to look and sound complicated to justify fees. Active managers even use a Greek word — alpha — to describe what other industries call “doing your job.”
Most of what you need to know about investing can be explained in simple terms, even if it’s based in complicated math. And just as with teaching, those who travel in simple terms perform far better than those who bury themselves in technical details. Lots of investors understand the math and technical details behind their investments, but not the simplified, realworld consequences of what they’re doing. The result is regular disappointment. Quantitative hedge funds blowing up, unshakable faith in back-tested models, 4,000-word investment write-ups that don’t say anything. If you can calculate an investment thesis but not explain it in common sense terms to a group of non-investors, you’ll be eaten alive by your own brilliance.
On the other hand, dollar-cost averaging, long time horizons, value investing, inside ownership, shareholder yield ... these concepts are so simple and easily explained, and they capture the importance of investing without any added complication.
A few years ago, Warren Buffett asked a group of students which classmate they would choose if they could have 10 percent of that person’s earnings for life.
“Are you going to pick the one with the highest IQ?” he asked. “Are you going to pick the guy who can throw a football the farthest? The one with the highest grades?”
Nope. Students invariably pick classmates with traits like integrity, honesty and kindness.
Same idea here. Common sense rules of thumb explain so much that technical details miss.