The purpose of the following series is to help our subscribers view the world in a unique and develop a rational mindset. A rational mindset is the best ally to an investor, as investing in emotions sometimes cripples the mind. Understanding the world around you and thinking rationally enables you to improve your day-to-day decision making.
When I was new to investing, people would always tell me to think rationally and look at the world as an investor and I did not know where to start from. It’s easier said than done and especially harder when people are not willing to divulge their secrets.
In today’s article, I’m going to introduce you to a checklist.
An important lesson I learnt from my Military career, was to always carry a pen and notebook on me at all times.
In the back of the notebook, I have written 5 Principles, that are manifested in virtually all human endeavours, from personal choices to global policies.
What this does, it provides me with the tools to focus and narrow my scrutiny to examine any decision, yours or someone else’s, in terms of incentives, seeing the world as a system with limited resources, and seeing all human interactions as interconnected and beyond careful control.
I apply the checklist to look at situations as diverse as the rise of Nationalism to purchasing detergent from Coles.
I want to show you a unique way to navigate the world of information asymmetry, found, among other places, in retail shopping, job searches, and political campaigns.
We then scope 2 factors in the impact of timing, the value of money, and psychology. This will all help you with investing.
Let’s get straight to the 5 principles:
Principle 1: Everyone responds to incentives
Principle 2: There is no such thing as a freebie
Principle 3: There are always two sides to a viewpoint
Principle 4: The law of unintended consequences
Principle 5: No one is ever in complete control
Principle number 1: Everyone responds to incentives
Everybody responds to incentives, it’s a universal factor. From the dark ages to modern times, people will always do more of something if they are rewarded. If an action is disciplined, they’ll do less of it.
When I was in university and scraping the floor for money, there used to be a Malaysian shop I always went to, for lunch. The lunch cost 6 dollars and was nothing fancy and very basic, however, I kept returning to the place due to a tactic they used. If you were a university student you got a card, in which they put a stamp every time you had lunch and once you got 10 stamps, you had a free meal.
Only much later did I realise that every free meal cost me 60 dollars. Still in the mind of a university student who was scraping by it seemed like a great deal. The same opposite principle applies to cigarettes. If you tax cigarettes more, people will smoke less.
Principle number 2: There is no such thing as a freebie
Nothing in this world is free, everything has a price. An investor looks at the world and sees a grand circus playing out. In this circus they see the wants competing with the limited resources in hand, every investor understands that at any given time there is always going to be a scarcity.
Any use of time or limited resources for one purpose is an opportunity forever gone to use them for another. More of anything always means less of something else, and it’s that option that you had to give up that investors call opportunity cost.
Opportunity cost is the value of the next-best-thing that must be given up when time or resources are devoted to one use. It is what is forgone.
Principle number 3: There are always two sides to a viewpoint
As an investor, I said earlier it is important to be rational and not emotional. To any given matter, you need to know what the viewpoints are. People might say a particular opportunity is great and some might say it’s a smoking gun.
As an investor, it is your responsibility to understand the core principles driving both sides of the spectrum, to critically analyse the facts and come to a rational conclusion using your independent mind.
Principle number 4: The law of unanticipated consequences
For those familiar with Chaos theory, this concept is referred to as the butterfly effect. In chaos theory, hypothetically, a butterfly on one side of the world can flap ap its wings and, through a chain of causation that’s totally unpredictable, cause a hurricane on the opposite side of the world.
An investor understands that nothing ever happens in a bubble; a change in one part of the economic landscape is bound to have foreseen and unforeseen ripple effects in far-removed places.
I will use an e.g. from an interesting article I was reading when researching Silver. During the Islamic Revolution, the dental cost in Iran went up. Now, this seems like a strange coincidence.
The article went on to explain that when the revolutionaries took over the U.S. embassy in Tehran. There was a real fear that the United States might go to war in the Middle East, which could result in the disruption of the international financial markets. This led to many investors protecting their assets by buying gold and silver as a hedge against this uncertainty, which impacted the costs of dental because they use silver in their fillings and the cost of silver had gone up.
Every investor understands that they are often impacted by things they cannot anticipate or control and always have a contingency in place.
Principle number 5: No one is in complete control.
As an investor, you have to accept the fact that you can never be, in complete control. If you apply an incentive to some subset of 6 billion complexly interrelated people, whose interactions are totally unforeseeable and have unintended consequences, and then predict the final result, that would be monumental. To go further and try to control that outcome would be utterly impossible.
What I hope you take away from reading this article is that investors look to the incentives facing decision-makers to predict, explain, or prescribe their choices and the behaviour of the market.
They also realise that nothing is truly free and there is always a cost in terms of opportunities forgone, even if it is not in the traditional terms of money