Thursday, February 23, 2006

Practice Makes Permanent

It is fairly easy for Jonathan, a 5-year-old kid taking his tennis lessons every weekend to improve than it is for Roger Federer. I think the reason lies in the transition of thought process associated with the game from System 2 to System 1, a concept well explained by Daniel Kahneman and Amos Tversky.

Two System Thinking:

They use this term to distinguish intuition from reasoning, where

Intuition (System 1):
Intuitive operations are basically fast, automatic, effortless, associative, and difficult to control (or) modify. Think of Pete Sampras’ serve.

Reasoning (System 2):
These operations are basically slower, effortful, and deliberately controlled. The other two defining characteristics of this process are: they are rule governed and flexible. That is why a kid who is most flexible (or quick learner) and a great teacher (say a guy who knows what works) will make a great combination (think Warren Buffett and Benjamin Graham.)

System 1 (Intuition) & Status Quo Bias:
Status quo bias is a consequence of system 1 (Intuitive) mode of thinking. I also think that status quo bias is a big drag on unleashing human potential to its best possible level. But we don’t realize it because what’s forgone can only be measured in opportunity cost whereas the advantages associated with it are ‘psychological and real.’ I will try and discuss the psychological (dis) advantages in the next section.

Human Beings Hate Uncertainty:
Willingness to change is a strength, even if it means plunging part of the company into total confusion for a while”—Jack Welch.

This can be cited as very uncommon behavior because associated with the confusion is the whole lot of uncertainties. It is under such conditions of uncertainty that we are most susceptible to all the biases, as explained by Dr. Cialdini,

When we are unsure of ourselves, when the situation is unclear or ambiguous, when uncertainty reigns, we are most likely to accept the actions of others as correct

Thus I think we tend to stick to what is consistent with the current setting when all we forgo for doing so is measured in opportunity cost, which nobody cares to address when they don’t have any incentives to do so.

Grandma’s Rule:
It says “You have to eat the carrot before you get the dessert.”

While thinking about how to overcome status quo bias, I realized that it is not the lack of insights that hold us form seeking change, but the lack of enterprise or incentives to carry out the change. For example, we often hear our inner voice claim that from now on we have got to change this and that, but many a times that tomorrow never comes. To make sure that we accomplish what we think we should, we can set incentives for ourselves. I remember reading somewhere that Warren Buffett decided that he would not invest unless he reads “Intelligent Investor” eleven times. I don’t bet on the authenticity of this but I surely think that this is a good example as to how to set incentives for ourselves. After all, Incentives are super-powers.

“Practice makes permanent—not perfect”—Warren Buffett.

As an investor, it is only natural to work hard to try and make security analysis as effective as possible. It is also natural that as we practice harder, it will tend to become less effortful. But at the end of the day, security analysis is not an exact science but an art where it pays to stick to certain well-grounded principles and also be flexible.

To be flexible, we need to be receptive to the feedback we receive from the system (ie) success or failure of an idea, as the case may be, and try and incorporate the learning in our collective thought process.

“One mended fault is always better than two found faults”—Ben Franklin.