Inflation Protection for Long-Term Investors

8 Principles to Become an Exceptional Performer

We all experience the joys and frustrations of learning a new skill. From athletics, to music, to our professional lives, we strive to master our craft and improve our ability. Weekend golfers try to take strokes off their game, amateur musicians strive to create new music, and doctors work to better care for their patients.

Some have highly specific goals in mind and devote constant effort to improvement. Others may take a relaxed, less intense approach. Both groups encounter similar frustrations along the way. Why do we often plateau and struggle after a period of time? Why do some people improve at a faster rate than others?

Given our busy lives and competing demands, how can we best improve from average to exceptional?

K. Anders Ericsson has spent his professional life figuring out what separates elite performers from the average masses. As a Florida State psychology professor and author of Peak: Secrets from the New Science of Expertise, Ericsson is the go-to expert behind the principles of exceptional performance. His results and lessons are counterintuitive. What doesn’t matter is innate talent or genetics. What does matter is the deliberate and focused attention we apply to our practice and training.

To preview, we have complete control of our ability to learn any new skill. However, society reinforces the myth that experts are born and not made, making deliberate effort a fruitless endeavor. It’s a mindset instilled when we are young. We rationalize poor performance and deflect personal responsibility. Instead of accepting responsibility, we blame a lack of talent.

Ericsson’s research has proven this wrong. Let’s explore how to apply 8 principles, based on Ericsson’s work, to become an elite performer.

1.      Your Abilities are not Fixed

…both the brain and the body retain a great deal of adaptability throughout adulthood, and this adaptability makes it possible for adults, even older adults, to develop a wide variety of new capabilities with the right training…If you talk to these extraordinary people, you find that they all understand this at one level or another. They may be unfamiliar with the concept of cognitive adaptability, but they seldom buy into the idea that they have reached the peak of their fields because they were the lucky winners of some genetic lottery. They know what is required to develop the extraordinary skills that they possess because they have experienced it firsthand. - Peak: Secrets from the New Science of Expertise

The first idea is the belief that your abilities are not fixed. Once you believe you can influence and change yourself, you see struggles as learning opportunities, not judgments on your self-worth. You must develop the habits and routines to transform struggles into learning lessons to build permanent change.

But we now understand that there’s no such thing as a predefined ability. The brain is adaptable, and training can create skills—such as perfect pitch—that did not exist before. This is a game changer, because learning now becomes a way of creating abilities rather than of bringing people to the point where they can take advantage of their innate ones. In this new world it no longer makes sense to think of people as born with fixed reserves of potential; instead, potential is an expandable vessel, shaped by the various things we do throughout our lives. Learning isn’t a way of reaching one’s potential but rather a way of developing it. We can create our own potential. - Peak: Secrets from the New Science of Expertise

It’s about creating and developing new skills, not uncovering hidden skills. There is no such thing as hidden talent. We have been taught that we should search for our inherent passion because that must be the one thing we will be good at. We now understand there are very few things genetically “set” from the beginning and almost all new skills can be created and developed. The important question is how to create those skills.

2.      Hard Work is not Enough

But sometimes these books leave the impression that heartfelt desire and hard work alone will lead to improved performance— “Just keep working at it, and you’ll get there”—and this is wrong. The right sort of practice carried out over a sufficient period of time leads to improvement. Nothing else. - Peak: Secrets from the New Science of Expertise

“Just Work Hard”. Those three words are misused more often than any other piece of advice. It’s appealing because it makes sense on the surface. Of course nothing meaningful develops with partial effort. Read the histories of great leaders or musicians and you will always find a hard-fought struggle. We are taught this from an early age from our parents or coaches. It’s a good attitude to cultivate.

But there’s a problem. The growth benefits of hard work stop after a certain amount of time. No matter how much hard work we put in, our ability stops improving. It’s a frustrating situation. Why is something that worked in the past all of a sudden not working?

It stops working because we no longer direct that hard work into routines that stretch and expand our skills. We just repeat what we know, without embracing new challenges. Our abilities no longer respond to traditional hard work. We need something else…

Why should the teaching techniques used to turn aspiring musicians into concert pianists have anything to do with the training that a dancer must go through to become a prima ballerina or the study that a chess player must undertake to become a grandmaster?

The answer is that the most effective and most powerful types of practice in any field work by harnessing the adaptability of the human body and brain to create, step by step, the ability to do things that were previously not possible. - Peak: Secrets from the New Science of Expertise

The underlying habits and principles behind world class performance apply equally to athletics, music, or entrepreneurship. While the day-to-day activities are different, the principles of training design and growth are constant across domains.

If you wish to develop a truly effective training method for anything—creating world-class gymnasts, for instance, or even something like teaching doctors to perform laparoscopic surgery—that method will need to take into account what works and what doesn’t in driving changes in the body and brain. - Peak: Secrets from the New Science of Expertise

We miss harnessing the power to optimize how our mind incorporates and masters new skills. We’ve been coasting along, using vague ideas like “working hard” without realizing it’s only half the equation. The other half, based on Ericcson’s research, is too often neglected.

3.      Showing Up is not Enough

We all follow pretty much the same pattern with any skill we learn, from baking a pie to writing a descriptive paragraph. We start off with a general idea of what we want to do, get some instruction from a teacher or a coach or a book or a website, practice until we reach an acceptable level, and then let it become automatic. And there’s nothing wrong with that. For much of what we do in life, it’s perfectly fine to reach a middling level of performance and just leave it like that. - Peak: Secrets from the New Science of Expertise

So far, so good. With the help of a coach and some instruction, we practice and make progress. As Ericsson stated, that works for most activities in life. We don’t have to be superb at everything. But what about the skills we do want to be superb at? Why do we struggle to progress beyond good enough?

But there is one very important thing to understand here: once you have reached this satisfactory skill level and automated your performance—your driving, your tennis playing, your baking of pies—you have stopped improving. - Peak: Secrets from the New Science of Expertise

Most of us reach an acceptable level without knowing it. We keep practicing and assume we are improving, yet our real-world performance never improves.

How do we overcome this? Testing and feedback. We need to continually test our skills to provide objective feedback on our current ability. Without testing, we are left to guess at our skill level. And guesses don’t work for elite performers.

Testing provides feedback, giving us the direction and data to redirect our routines and practice. Our practice habits must evolve and adapt. If we keep the same static practice routines, we never develop new ways to improve our weaknesses.

People often misunderstand this because they assume that the continued driving or tennis playing or pie baking is a form of practice and that if they keep doing it they are bound to get better at it, slowly perhaps, but better nonetheless. They assume that someone who has been driving for twenty years must be a better driver than someone who has been driving for five, that a doctor who has been practicing medicine for twenty years must be a better doctor than one who has been practicing for five, that a teacher who has been teaching for twenty years must be better than one who has been teaching for five.

But no. Research has shown that, generally speaking, once a person reaches that level of “acceptable” performance and automaticity, the additional years of “practice” don’t lead to improvement. If anything, the doctor or the teacher or the driver who’s been at it for twenty years is likely to be a bit worse than the one who’s been doing it for only five, and the reason is that these automated abilities gradually deteriorate in the absence of deliberate efforts to improve. - Peak: Secrets from the New Science of Expertise

The dirty secret of “experience” is that people with 20 or 30 years of experience are often no better than those with 10 or 15 years of experience. We may want to believe that more is better, but have we ever tested or validated that assumption? Probably not. Most likely, we have assumed we must be better because we need to justify the years of effort and time invested. It’s agonizing to think about spending 20 years doing something and not improving. But we have to face reality, not what’s comfortable, if we want to grow.

This brings back the importance of testing and feedback. We must have objective guidance on our ability. If we assume or guess, we are fooling ourselves into believing we are something that we are not. And that is the downfall of anyone striving to become exceptional at their skill.

4.      Engage in Purposeful Practice

Purposeful practice has several characteristics that set it apart from what we might call “naive practice,” which is essentially just doing something repeatedly, and expecting that the repetition alone will improve one’s performance.

Purposeful practice has well-defined, specific goals. Our hypothetical music student would have been much more successful with a practice goal something like this: “Play the piece all the way through at the proper speed without a mistake three times in a row.” Without such a goal, there was no way to judge whether the practice session had been a success. - Peak: Secrets from the New Science of Expertise

By using goals, you transform random action into deliberate processes. Goal-based practice can be tracked and measured, providing valuable feedback. By focusing on specific goal-driven processes, we build practical skills.

Purposeful practice is all about putting a bunch of baby steps together to reach a longer-term goal.

Purposeful practice is focused.

Purposeful practice involves feedback. You have to know whether you are doing something right and, if not, how you’re going wrong.

Purposeful practice requires getting out of one’s comfort zone.

- Peak: Secrets from the New Science of Expertise

These four ideas move your actions beyond showing up and instead direct your effort into long-term progress. Small steps, focus, feedback, and uncomfortability are necessary for growth.

5.      Get Comfortable with being Uncomfortable

This is a fundamental truth about any sort of practice: If you never push yourself beyond your comfort zone, you will never improve…Generally the solution is not “try harder” but rather “try differently.” It is a technique issue, in other words.

The best way to get past any barrier is to come at it from a different direction, which is one reason it is useful to work with a teacher or coach. Someone who is already familiar with the sorts of obstacles you’re likely to encounter can suggest ways to overcome them. - Peak: Secrets from the New Science of Expertise

Purposeful practice focuses on things we can’t do well. If we keep repeating the things we are good at, we never overcome the obstacles that hold us back. Confronting our weaknesses is painful. It requires honesty and humility about our shortcomings. Practicing our weak points isn’t fun. It’s much easier to practice the things we are good at, since it’s inherently enjoyable to succeed. But we don’t progress when repeating the things we are good at.

If you can’t find a coach to provide feedback, you must create your own feedback to leverage. If it’s a physical skill, a video recording provides an impartial, outside look at your performance. If it’s academic/knowledge based, testing delivers valuable feedback. You may be tempted to skip these ideas and just “trust” your instincts. Unfortunately, you will be stuck wondering why you don’t see the progression you expect.

6.      Separate Knowledge from Skills

When you look at how people are trained in the professional and business worlds, you find a tendency to focus on knowledge at the expense of skills. The main reasons are tradition and convenience: it is much easier to present knowledge to a large group of people than it is to set up conditions under which individuals can develop skills through practice. - Peak: Secrets from the New Science of Expertise

Always separate knowledge from skill. It’s easy to add knowledge and confuse that with skill improvement. When we think of learning, we assume knowledge accumulation is good. But knowledge accumulation that doesn’t transfer to applied skills doesn’t help us. We may feel confident in the moment but we are mistaking that confidence for progress. Think about this. Of all the books you have read in your lifetime, how many have delivered actionable improvement? Have you converted that knowledge into long-term, applied skill?

From the perspective of deliberate practice, the problem is obvious: attending lectures, minicourses, and the like offers little or no feedback and little or no chance to try something new, make mistakes, correct the mistakes, and gradually develop a new skill. It’s as if amateur tennis players tried to improve by reading articles in tennis magazines and watching the occasional YouTube video; they may believe they’re learning something, but it’s not going to help their tennis game much. Furthermore, in the online interactive approaches to continuing medical education, it is very difficult to mimic the sorts of complex situations that doctors and nurses encounter in their everyday clinical practice.

It is not just the medical profession that has traditionally emphasized knowledge over skills in its education. The situation is similar in many other professional schools, such as law schools and business schools. In general, professional schools focus on knowledge rather than skills because it is much easier to teach knowledge and then create tests for it. The general argument has been that the skills can be mastered relatively easily if the knowledge is there. One result is that when college students enter the work world, they often find that they need a lot of time to develop the skills they need to do their job. Another result is that many professions do no better a job than medicine—and in most cases, a worse job—of helping practitioners sharpen their skills. Again, the assumption is that simply accumulating more experience will lead to better performance. - Peak: Secrets from the New Science of Expertise

As an investing professional, I’ve struggled to convert information into skill improvement. I’ve found it’s easy and seductive to absorb information, but much more challenging to find evidence my investing skill has actually increased. That’s the challenge for all knowledge workers. How do you ensure your skills are improving?

7.      Create Daily Routines

The hallmark of purposeful or deliberate practice is that you try to do something you cannot do—that takes you out of your comfort zone—and that you practice it over and over again, focusing on exactly how you are doing it, where you are falling short, and how you can get better. Real life—our jobs, our schooling, our hobbies—seldom gives us the opportunity for this sort of focused repetition, so in order to improve, we must manufacture our own opportunities. - Peak: Secrets from the New Science of Expertise

Deliberate and focused effort doesn’t happen by itself. We all have busy lives with little free time. Without consciously directing our behavior towards building expertise, we will never create consistent time for improvement. The first step must be a conscious decision to allocate time to this process. You will have to give something up. No one said this will come without at cost.

A similar thing is true for those who maintain purposeful or deliberate practice over the long run. They have generally developed various habits that help them keep going. As a rule of thumb, I think that anyone who hopes to improve skill in a particular area should devote an hour or more each day to practice that can be done with full concentration. Maintaining the motivation that enables such a regimen has two parts: reasons to keep going and reasons to stop. When you quit something that you had initially wanted to do, it’s because the reasons to stop eventually came to outweigh the reasons to continue. Thus, to maintain your motivation you can either strengthen the reasons to keep going or weaken the reasons to quit. Successful motivation efforts generally include both. - Peak: Secrets from the New Science of Expertise

Habits, routines, and schedules provide a necessary structure to enable commitment and persistency of the task at hand. Relying on willpower, luck, or fate won’t last. By creating a consistent habit to practice one hour a day, at a regular time, we stop trying to fit it in our schedule but rather fit our schedule around the practice. Once our routine is locked in our schedule, there is no ambiguity or uncertainty of when it will be done.

One of the best bits of advice is to set things up so that you are constantly seeing concrete signs of improvement, even if it is not always major improvement. Break your long journey into a manageable series of goals and focus on them one at a time—perhaps even giving yourself a small reward each time you reach a goal. -Peak: Secrets from the New Science of Expertise

Instead of trying to tackle a hundred things at once, practice the building blocks one at a time. Focus each practice day on one unique aspect of your skill. Do this over the course of a year and you have a solid foundation of practical skills. Avoid the urge to do too much at one time. We all want to overachieve, but trying to do too much causes burnout and unfocused effort. Trust the process and commit to improving one thing at a time.

8.      Take Charge of Your Success

We need to start now. For adults who are already in the work world, we need to develop better training techniques—based on the principles of deliberate practice and aimed at creating more effective mental representations—that not only will help them improve the skills they use in their current jobs but that will enable them to develop new skills for new jobs. And we need to get the message out: you can take charge of your own potential. But it is the coming generations who have the most to gain.

The most important gifts we can give our children are the confidence in their ability to remake themselves again and again and the tools with which to do that job. They will need to see firsthand—through their own experiences of developing abilities they thought were beyond them—that they control their abilities and are not held hostage by some antiquated idea of natural talent. - Peak: Secrets from the New Science of Expertise

Success results from conscious and deliberate effort to improve our skills. No one will do this for you. As the world becomes more competitive and meritocratic, it’s your responsibility to grow your skills and demonstrate expertise. The idea of genetics or innate talent limiting your potential isn’t the real constraint. We have 10x the potential if we learn and grow using the principles of exceptional performers.

Peak Takeaways:

1.      Your Abilities are not Fixed

2.      Hard Work is not Enough

3.      Showing Up is not Enough

4.      Engage in Purposeful Practice

5.      Get Comfortable with being Uncomfortable

6.      Separate Knowledge from Skills

7.      Create Daily Routines

8.      Take Charge of Your Success

How to Become a Better Investor: 4 Principles Behind Exceptional Investment Decisions

Instead of searching for the next hot investment idea, we should strive to make sustainable, above average investment decisions. Successful investing isn’t based on home-run type bets. It’s based on sound decision making over many years. To do this, we need to develop principles to guide our decisions regardless of the market environment. Since the future is unknown and will not be exactly like the past, we can’t rely on rigid rules to guide us in every situation. Principles, however, can be adapted and applied to all environments.

To become a better investment decision maker, we should focus on process, not outcome. Many investors judge their decisions by how well their choice worked out. If the stock they picked went up, they conclude it was a good decision. If it went down, it was a bad decision. This analysis is misguided. In the short run, luck and randomness dictate many outcomes. We can be right for the wrong reason. For example, winning money at a casino may be viewed as a good decision, but it was actually a bad decision bailed out because luck was in your favor. If you continue to play at the casino, I can guarantee you will end up with a bad outcome. Luck isn’t a sustainable process. Because the process behind this decision is stacked against you (the odds favor the casino), judging your success by one outcome masked the flawed process underneath.

We encounter the same thing as investors. We buy a stock for the wrong reason, and when it goes up, we take credit for the great decision. Except that it wasn’t a great decision. It was just lucky. We constantly confuse luck and randomness with the quality of the underlying decision-making process. We need to focus on the process to make correct decisions. Any one decision may not go the way we want it – that’s just reality. But what we can’t do is judge ourselves based on one-time examples. We need to judge our decisions making by examining the reliability and accuracy of our underlying process.

Investors, like superforecasters, need to build a consistent and rational approach to decision making. Let’s examine how we can apply some of the principles behind Phillip Tetlock’s book, Superforecasting: The Art and Science of Prediction, to the investment world.  

Principle #1: Unpack the question into components. Distinguish as sharply as you can between the known and unknown and leave no assumptions unscrutinized. 1

Investors should also break down any decision into smaller components. By segmenting the decision into manageable parts, we can better understand the underlying fundamentals without being overwhelmed. We can pass judgement on each individual item and build up our understanding. Otherwise, we overcomplicate the situation by trying to comprehend too much at once.

We should separate the critical underlying assumptions for every decision. These are often buried deep and are usually neglected, unless each assumption is identified. Without examining these drivers, we don’t understand our investments. We also need to uncover the unknowns and the resulting risks. By doing this, we can prepare and plan accordingly.

We often fool ourselves into thinking we know more about our stocks then we really do. We focus on headline-type issues – earning per share, top-line growth, news flow, etc. While these play a role in analysis, we need a deep understanding of the company. For example, when thinking about growth, we need to look at what’s driving the growth. What is the incremental ROIC on that growth? Is it profitable growth above the cost of capital? Is it organic or acquisition driven? Funded by operating cash flow or debt/equity issuance? Is it sustainable? Is the growth protected from competition, or will competition compete away the value of that growth?

Principle #2: Adopt the outside view and put the problem into a comparative perspective that downplays its uniqueness and treats it as a special case of a wider class of phenomena. Then adopt the inside view that plays up the uniqueness of the problem.2

Investors should incorporate an outside view when making any decision. Renowned investor Michael Mauboussin states, “The outside view asks if there are similar situations that can provide a statistical basis for making a decision. Rather than seeing a problem as unique, the outside view wants to know if others have faced comparable problems and, if so, what happened. The outside view is an unnatural way to think, precisely because it forces people to set aside all the cherished information they have gathered.”

“An inside view considers a problem by focusing on the specific task and by using information that is close at hand and makes predictions based on that narrow and unique set of inputs. These inputs may include anecdotal evidence and fallacious perceptions. This is the approach that most people use in building models of the future and is indeed common for all forms of planning.”3

We regularly fail to take the outside view and normally focus on the inside view. We just care about the current decision in isolation and neglect all the other previous decisions that share common characteristics. These previous decisions provide valuable information. As Michael mentioned, the inside view traps us by viewing every decision as unique, instead of trying to learn from similar past decisions. Because the inside view is often complicated with bias, anecdotes, and noise, it provides a terrible basis for investment decisions. The more we can take an outside view and learn from other similar decisions, the better we can calibrate the true probability of making a correct decision.

For example, when buying a stock, investors often gravitate to salient but anecdotal evidence. How fast is the company growing? What has the stock price done? What does the market think of this stock? We latch onto these headlines as a foundation for making decisions. The better approach is to go back in history and look at other stocks with the same characteristics and see how those worked out. By doing that, we have a larger sample size to base a decision. The evidence is better supported because there are more examples that cancel out the idiosyncratic, “inside view” effects.

Instead of looking at our investments in isolation, compare them to similar investments in the past. How have they performed over time? Did those investments work out like expected, or were there unexpected changes that negated the fundamental premise of the investment? For example, if we invest in commodity investments, don’t just look at the current investment fundamentals in isolation. Look back and examine how other commodity investments worked out. We will be surprised how few commodity investments, with the same underlying premises, actually worked out as expected for the investor. By comparing our investment to a reference class, we bring in long-term experience and real case studies to help solidify our investment thesis. If we find more disconfirming evidence than we expected, we may not have such a great investment opportunity after all.

Principle #3: Also explore the similarities and differences between your views and those of others—and pay special attention to prediction markets and other methods of extracting wisdom from crowds.4

We should always be looking to challenge our assumptions and beliefs. We can’t know everything, and we often make mental mistakes. By honestly trying to figure out where we go wrong, we can improve our decision making and build better decision-making habits. Ask yourself, “Why am I seeing this as an opportunity when the rest of the market thinks different?” Am I wrong and the market has it correct? How can I find out? What additional research can I do to tilt the odds in my favor?

Markets usually get to the right decision, although there are moments where they spectacularly fail. We need to understand when the conditions exist for each of these scenarios. If we don’t, we will assume we have an informational edge when we are really just overconfident.

We need to seek other investors who disagree with us. This provides us with necessary counterbalance to our own mistakes and flawed reasoning. We can’t do this ourselves. We are too biased to be 100% independent when reviewing our own work and assumptions. We need someone who can provide an educated and independent assessment of our decision. It’s not easy to hear, but criticism is crucial to our success. We need discomfirming evidence. It doesn’t do us any good to talk to someone who already agrees with us. Chances are that both people are making the same reasoning errors or exhibiting the same mental biases.

The solution is simple. Instead of finding people that agree with us, we should seek people that disagree with us. Examine their arguments and try to understand the differences. It’s not easy. There is never definitive proof on either side. The goal of the exercise is to force us to uncover your own mistakes, biases, and misjudgments. Our ego is the biggest impediment to this process. It’s not fun thinking about how we are wrong. Instead of trying to prove how smart we are, we should go into these situations just trying to learn. We will be amazed how much we can grow as an investor when we stop trying to look smart and instead focus on learning.

Principle #4: Express your judgment as precisely as you can, using a finely grained scale of probability.5

All investment decisions are a matter of probability. Investors who think in terms of certainty or act with 100% confidence fail to understand reality. The world is too complex to have perfect information. It’s painful to acknowledge the limits of our understanding, but we can’t fool ourselves into thinking we know more than we really do. Great investors view all decisions along a probability spectrum. Since they know nothing is for certain, they wait until the odds are in their favor to make big investments. If the odds aren’t there, they wait. And wait. And wait. It might take years for compelling investment opportunities to appear. Investors must be exceptionally patient until the markets provide the right opportunities.

We need to frame our decisions as a series of probabilities. For example, we might assign different odds to how fast a company might grow and how profitable they will become. By doing this, it forces us to examine scenarios that we otherwise might neglect. Many investors just concentrate on the scenario they think is the most likely.

The probabilities are never exact and we will never know how close we got on any one particular decision. Applying higher level mathematics or complex algorithms doesn’t help either, as it will just deliver false precision. The critical idea is to force us to go through the thought process of challenging our own beliefs and examining scenarios that we normally would neglect. It will never be a perfect science, because in the short run reality is full of randomness, complexity, and uncertainty. In the long run, principles-based decision making delivers above average investment returns.

Probability based thinking can lead to counter-intuitive investments. For example, investors often view a highly volatile investment as “risky”. If they instead view that investment in terms of different scenarios of risk and reward, they may find an attractive investment. Even if the base scenario implies a high likelihood of a loss, an upside scenario may deliver a gain many multiples of that loss, leading to an asymmetric risk/reward payoff. Even though most investors neglect the opportunity because of the headline “risk”, astute investors can uncover opportunities in their favor by thinking with probabilities.

Notes:

1,2: From Superforecasting: The Art and Science of Prediction by Philip Tetlock and Dan Gardner

3: http://michaelmauboussin.com/excerpts/TTexcerpt.pdf

4,5: From Superforecasting: The Art and Science of Prediction by Philip Tetlock and Dan Gardner 

Become a Better Investor - 5 Principles from Warren Buffett's 2017 Annual Letter

A few weeks ago, Warren Buffett released his annual shareholder’s letter and again delivered some compelling insights for investors. Buffett’s timeless and simple investment principles are great lessons for all investors to revisit. Even if you don’t agree with Buffett on all of his political/personal views, his investing advice remains the gold standard for investors who want long-term, actionable wisdom. He honestly speaks his mind and backs up his words with action – often billions of dollars of action behind his investments. He has what most market pundits lack – skin in the game. When Buffett talks about investing when others are fearful, he backs that up by investing large amounts of money. This is a striking difference to most market advisors and strategists who recommend ideas, but rarely commit any of their own money. If there is real money, it’s the clients, and not theirs, at risk.

Buffett’s words are so powerful because he 1) has the track record to back up his claims and 2) he commits Berkshire capital when he says he will. Given these reasons, Buffett’s annual letter should be recommended reading for all investors. After digesting his latest annual letter, I’ve summarized 5 key principles investors should incorporate into their own process. Most of these are not new, but unfortunately investors have a bad habit of forgetting obvious lessons. It pays to revisit these and the annual Buffett letter is a great way to do it.

Note: I highly recommend reading the letter in its entirety. Here’s a direct link to the letter. All italicized passages in this article are directly from the 2017 letter.

Principle #1: Investment success depends on the price paid, not just the inherent fundamentals of the underlying asset.

Here’s Buffett from the 2017 Annual Letter:

In our search for new stand-alone businesses, the key qualities we seek are durable competitive strengths; able and high-grade management; good returns on the net tangible assets required to operate the business; opportunities for internal growth at attractive returns; and, finally, a sensible purchase price. [my emphasis added]

That last requirement proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.

Buffett mentions many of the same things other investors emphasize – great companies, wide business moats, attractive reinvestment opportunities, superior management, etc. Hard to disagree with those. But when investors screw up, it’s often because they get the price wrong. Even though they find attractive companies, they pay too high of a multiple, leading to investment underperformance or negative returns, even though the underlying business is performing well.

Think about it – if price didn’t matter, Buffett wouldn’t be sitting on cash today. Surely he has identified great businesses he would like to own today. Why doesn’t he just buy these great businesses and watch them grow and grow and deliver great results for Berkshire shareholders? It’s simple - it wouldn’t work. As the price rises, returns on any investment migrate from great to good to mediocre to poor to disastrous. What you pay determines where on that scale you will fall.

 It’s tough work to figure out what you should pay. It’s a complex mix of discount rates, growth, return on investment, business/credit cycle, competition, and on and on. There’s never an easy answer and it will never be easy. That’s why investing is hard and there are so few Buffett’s. It’s not supposed to be easy.

Most investments across asset classes have simple and consistent valuation benchmarks to determine a reasonable price. It’s not an exact science. The point is to buy when there is a clear margin of safety. In today’s markets, most equities and fixed income assets are priced in the upper valuation ranges, some at extreme levels.

As Buffett mentions, investors need to exercise caution when allocating to risk assets. There is a growing sense of comfort and complacency in the market, given the recent tax cuts and continued economic growth. However, valuations already take this into account. It’s a fatal error to pick out arbitrary events (like the tax cuts) to justify higher and higher valuations. And there’s even debate on whether tax cuts will deliver any long term, net economic growth at all. Many investors who justify paying top decile valuations are doing so on a very shaky foundation. Historically (and mathematically), paying top valuations leads to subpar future returns.

It won’t turn out well for these investors. The sins of poor decision making today won’t be apparent until the future. It takes significant independent and long-term thinking to make wise investments in today’s markets. Buffett is clear about where he stands on valuations, and you as an investor should ensure you fully understand the price you are paying and the implications it will have on future returns. If you think valuations are reasonable today, prove to yourself you understand what has to go right to make sure the future turns out the way you need it to.

Principle #2: Beware of leverage as it often hides fatal flaws in many investments. Leverage takes a mediocre return and creates the illusion of an exceptional return. Unfortunately, investors don’t realize this into it's too late.

Here’s Buffett from the 2017 Annual Letter:

The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity. After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed. At Berkshire, in contrast, we evaluate acquisitions on an all-equity basis, knowing that our taste for overall debt is very low and that to assign a large portion of our debt to any individual business would generally be fallacious (leaving aside certain exceptions, such as debt dedicated to Clayton’s lending portfolio or to the fixed-asset commitments at our regulated utilities). We also never factor in, nor do we often find, synergies.

It’s obvious that a bad business, loaded up with debt, is a disaster waiting to happen. However, it’s less obvious that good businesses with too much debt often suffer the same fate. Leverage is seductive. Leverage enhances returns, growth, and EPS. For a while at least. Even the worst business can show earnings growth by either buying another company or investing internally, if it’s fueled with cheap debt. It works in the short-term and will continue as long as the current environment doesn’t change. But economies, markets, and businesses are subject to a shockingly high degree of unforeseen change and disruption, all of which will destroy leveraged investments and transactions.

Business executives and investors fall victim to this curse. It’s hard to resist borrowing cheap money when there appears to be arbitrage like opportunities to put that money to work in higher returning investments. The fatal flaw in this process is the simple: the future will not remain like the present. Investors often deal with an unknown future by extrapolating current trends and assuming the environment will stay the same.

Investors who have studied their history understand that the past is filled with unexpected shocks and regime changes in the markets. Growing economies go into deep recession. Great businesses face new competition that destroy their current business model. Free flowing credit markets seize up, causing solid businesses to face a liquidity squeeze when their debts mature. Accommodating markets can quickly become unaccommodating, so leverage will swiftly impair investments when the cycle turns.

It’s not an easy thing to do, but at some point investors need to decide whether they are on the offensive or defensive. As Howard Marks has stated, you can’t have both. You can’t get all the return you want and be super defensive. It’s one or the other.

Buffett chooses defense. As he mentions in the letter, he evaluates deals on an all equity basis, even though adding leverage would enhance the return. He doesn’t count on synergies, even though they would make the acquisition more attractive. Investments based on leverage and synergies rarely deliver the promised returns to investors. Investors would be wise to remember this lesson as they evaluate new investments. Separate the speculation (leverage, synergies, high growth forecasts) for the likely reality (little synergies and modest growth).

Principle #3: While holding “safe” investments remains unpopular with many investors, it provides the necessary dry powder to withstand market shocks and take advantage of market opportunities.

Here’s Buffett from the 2017 Annual Letter:

Charlie and I never will operate Berkshire in a manner that depends on the kindness of strangers – or even that of friends who may be facing liquidity problems of their own. During the 2008-2009 crisis, we liked having Treasury Bills – loads of Treasury Bills – that protected us from having to rely on funding sources such as bank lines or commercial paper. We have intentionally constructed Berkshire in a manner that will allow it to comfortably withstand economic discontinuities, including such extremes as extended market closures.

Buffett is content sitting with billions of short-term Treasury Bills, a rare thought for most investors. Why does he do it? It goes back to the first principle – he can’t find attractive investments at today’s valuations. He’s patiently waiting for the next opportunity.

Should investors copy Buffett and sit in cash as well? It’s a tougher call for most investors. Obviously, most investors can’t match Buffett’s investment capability, temperament, and business analysis ability. It pays for investors to remain towards a fully invested portfolio. While investors don’t have to make a drastic move to safer assets, they should move enough to remain comfortable during the next downturn. A higher allocation to “safe” assets makes sense when valuations and expected returns are subpar or even negative.

Unfortunately, many investors neglect this and it’s not because they necessarily disagree with the logic. They don’t deny you should buy more assets when prices are low and sell assets when prices are high. Buy low, sell high. The problem sits with their emotions – as risk assets like stocks continue to run up, investors can’t handle the thought of missing out on future gains if the markets continue to rise. In short, they become momentum traders and hope the market continues to rise. But all economic, business, and credit cycles come to an end. If investors are top heavy in risk assets at the peak, they will suffer excessive losses on the way down. The solution is not to dump all the risk assets and sit in cash. It doesn’t have to be an extreme move. But investors should tilt away and rebalance to safer assets when valuations call for it. That’s why its imperative to have a fundamental gauge to judge the attractiveness of asset classes. It doesn’t have to be complicated – a moving average P/E for stocks, a long-term average spread level for bonds, etc.

The biggest problem comes back to investor’s emotional biases – they can’t stand re-allocating away from assets that have recently done well. The “buy low, sell high” logic is thrown out as they are seduced by the easy money being made today. But it will end, as it always does. Remember, the lesson is not to completely dump stocks and go to cash. The idea is to remember that all good markets come to and end, and investors need to consider their ability to handle a down market, and structure their portfolio accordingly.

Principle #4: In the short-term, prices disengage from fundamentals, often in a violent and unpredictable manner. Investors who are prepared for them will succeed, those who are unprepared will fail.

Here’s Buffett from the 2017 Annual Letter:

Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure long-term growth in value. For the last 53 years, the company has built value by reinvesting its earnings and letting compound interest work its magic. Year by year, we have moved forward. Yet Berkshire shares have suffered four truly major dips. Here are the gory details:

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This table offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.

Buffett emphasizes the lesson on the inherent dangers of adding leverage to an equity portfolio. As Buffett states, even a portfolio with high quality Berkshire shares would have been decimated if leverage had been added.

There is a bigger lesson here than just the dangers of leverage. It’s the idea that in the short-term prices can drop to wildly unexpected levels. Many investors aren’t ready when this happens, resulting in knee-jerk reactions and emotionally charged investment blunders. If quality investments like Berkshire fall over 50% in these time periods, imagine what happens to lower quality companies! There are two lessons here. First, these events, while unexpected, happen regularly in the markets. Second, the goal is not to predict these events, but the prepare for these events. Investors who are mentally ready and have dry powder to deploy will use these opportunities to make exceptional investments at absolute bargain prices. Investors who are not ready will often panic, sell out at the bottom, and lock in huge losses and forego any participation when the market recovers. Same market event, but two completely different outcomes, all based on the preparation of investors before these events occur.

Principle #5: Many active managers have failed to deliver their promise to investors. Hedge funds, fund of funds, and other active managers continue to lag their respective benchmarks, often by a large amount. Investors need to challenge their own conviction when allocating to active managers, making sure they really understand the unique capabilities of their managers.

In 2007, Warren Buffett made a simple bet with Protégé Partners. Buffett bet that the S&P 500 would outperform a group of five fund of funds over a ten-year period. Protégé, an advisory firm, selected a group of fund of funds and bet they as a group would outperform the S&P 500, after all fees and expenses. Buffett was making a bet based on something he has believed for a long time – the performance of most Wall Street products and strategies, after including the layers of fees and expenses, end up delivering staggeringly low returns to investors while enriching the managers. Buffett and Protégé each put up money that would be donated to the winner’s charity of choice at the end of the 10 years. Below is Buffett’s recap of the bet that just ended this year.

Here’s Buffett from the 2017 Annual Letter:

 “The Bet” is Over and Has Delivered an Unforeseen Investment Lesson

I made the bet for two reasons: (1) to leverage my outlay of $318,250 into a disproportionately larger sum that – if things turned out as I expected – would be distributed in early 2018 to Girls Inc. of Omaha; and (2) to publicize my conviction that m

The 90% Rule: Making Better Investments with Less Anxiety

A Nonessentialist approaches every trade-off by asking, “How can I do both?” Essentialists ask the tougher but ultimately more liberating question, “Which problem do I want?” An Essentialist makes trade-offs deliberately. She acts for herself rather than waiting to be acted upon. As economist Thomas Sowell wrote: “There are no solutions. There are only trade-offs.”

You can think of this as the 90 Percent Rule, and it’s one you can apply to just about every decision or dilemma. As you evaluate an option, think about the single most important criterion for that decision, and then simply give the option a score between 0 and 100. If you rate it any lower than 90 percent, then automatically change the rating to 0 and simply reject it. This way you avoid getting caught up in indecision, or worse, getting stuck with the 60s or 70s. – Essentialism, George McKeown

In his book, Essentialism, George McKeown illustrates the benefits of deliberately making trade-offs to build a better and more “essential” life. His 90% rule consciously directs our focus and energy by eliminating decisions that fall below 90%. Logically, this means eliminating many good ideas that we would normally pursue. Why would we do that?

We rarely consider the negative effects of chasing all the good/average/mediocre decisions because we don’t consciously track the unintended consequences. It seems worthwhile until we consider the full cost of our actions. We pursue too many good decisions instead of focusing on a few great ideas. Chasing too many decisions leads to never-ending distractions and an overwhelming sense of “busyness”.

In today’s environment, investors have the same problem. By chasing hundreds of news stories, ideas, and recommendations, we end up distracted, overwhelmed, and ultimately ignorant. We don’t invest the energy in mastering the important principles. Consequently, we unknowingly make poor investments without realizing it until it’s too late. We feel like we should always be doing something – making a trade, firing a manager, or reading a headline. There is a perpetual action bias as patience is viewed with scorn. In an upward market, investors don’t have the patience to sit in safer assets. One of the worst things an investor can do is lose patience and settle for poor opportunities.

The 90% rule makes us slow down and consciously consider our ideas. Great investors aren’t trading every day. They have a few big ideas per year. That’s it. The notion that we need come up with exceptional ideas every week is unrealistic and leads to mindless activity. Investing is a game of quality, not quantity. We only need a few great investments over the course of many years to deliver exceptional results. We need to raise our standards when we take on risk to ensure we are adequately compensated for doing so. When we abandon that principle, we have little margin of safety when things don’t work out as we expected. The 90% rule isn’t perfect, but it avoids the marginal ideas that often get us in trouble. The 90% rule would stop a lot of bad investments. Because of our bias to settle for good ideas, our portfolios end up stuffed with marginal investments, instead of a high conviction, best ideas portfolio.

“Hell Yeah or No”

Entrepreneur Derek Sivers created the same rule to decide his commitments and areas of focus. He calls it the “Hell Yeah or No” rule.

Derek explains -

Use this rule if you’re often over-committed or too scattered. If you’re not saying “HELL YEAH!” about something, say “no”. When deciding whether to do something, if you feel anything less than “Wow! That would be amazing! Absolutely! Hell yeah!” — then say “no.” When you say no to most things, you leave room in your life to really throw yourself completely into that rare thing that makes you say “HELL YEAH!”. Every event you get invited to. Every request to start a new project. If you’re not saying “HELL YEAH!” about it, say “no”. We’re all busy. We’ve all taken on too much. Saying yes to less is the way out. - https://sivers.org/hellyeah

Derek emphasizes that anything less than a “Hell Yeah”, is a “No”. Does that mean rejecting perfectly good ideas? Absolutely. We need give up the good opportunity today to capture the exceptional opportunity in the future. Adopting this rule makes life easy and delivers better results. The more we agonize over a good idea, the more time and energy we waste. It seems painful in the moment to reject a good idea. Remember, exceptional investments, just like ideas, are not evenly distributed – they come in bunches, waves, and clusters. Just because we don’t see a compelling investment today, we shouldn’t force the issue and trap ourselves in an average idea. If we’ve invested everything we have in good ideas, there is nothing left for the great ideas.

Buffett’s 90% Rule

Warren Buffett says it best. He talks about waiting for the fat pitch – waiting for the odds to be heavily tilted in our favor before investing. Here’s an excerpt from his 1997 Annual Letter -

Under these circumstances, we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his "best" cell, he knew, would allow him to bat .400; reaching for balls in his "worst" spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors.

If they are in the strike zone at all, the business "pitches" we now see are just catching the lower outside corner. If we swing, we will be locked into low returns. But if we let all of today's balls go by, there can be no assurance that the next ones we see will be more to our liking. Perhaps the attractive prices of the past were the aberrations, not the full prices of today. Unlike Ted, we can't be called out if we resist three pitches that are barely in the strike zone; nevertheless, just standing there, day after day, with my bat on my shoulder is not my idea of fun.

When we can't find our favorite commitment -- a well-run and sensibly-priced business with fine economics -- we usually opt to put new money into very short-term instruments of the highest quality. Sometimes, however, we venture elsewhere. Obviously we believe that the alternative commitments we make are more likely to result in profit than loss. But we also realize that they do not offer the certainty of profit that exists in a wonderful business secured at an attractive price. Finding that kind of opportunity, we know that we are going to make money -- the only question being when. With alternative investments, we think that we are going to make money. But we also recognize that we will sometimes realize losses, occasionally of substantial size.- http://www.berkshirehathaway.com/letters/1997.html

“The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot,” Buffett has said. “And if people are yelling, ‘Swing, you bum!’ ignore them.”- http://www.omaha.com/money/buffett/warren-buffett-waits-for-a-fat-pitch-before-taking-a/article_40026e55-60c2-54b6-95c5-bbee134d1696.html

Because of institutional mandates, competitive pressures, and ingrained bad habits, investors swing at bad pitches. Investors must keep up with other investors because if they lag behind, they are fired. Investment committees, boards of directors, and clients want their money managers to “do something”, especially if other investors are making money. After all, why pay them to sit around and do nothing? It doesn’t take managers too long to understand they better start swinging at pitches, even if they are constantly striking out.

How can we overcome this? It’s not easy. We need to embed patience in our process. Get comfortable waiting, and waiting, and waiting. The ability to invest independently and at the right time/price is critical. Investors can’t be evaluated like a factory worker. You can’t measure investment productivity by looking at activity, action, or output. Superior investing is about capturing rare opportunities, not about how many trades we make. In fact, the more decisions we force ourselves to make, the worse the outcome. Fewer decisions done better.

In expensive markets, it’s challenging to find homerun ideas. It’s a natural consequence of high-priced markets. It doesn’t mean that investors stop looking for ideas. There are always mispriced assets, no matter the level of the general markets. They are just harder to find. More importantly, preparation today equips investors to make homerun investments when those opportunities arise.

The worst thing an investor can do is give up on the 90% rule and settle for mediocre ideas. It’s tough to remain patient when the markets continue to hit all-time highs. The fear of missing out is real.

Charlie Munger’s Advice

Charlie Munger, Warren Buffett’s business partner, explains another variation of the 90% rule - Buffett’s 20 punch rule.

Here’s Charlie from his USC Commencement Speech -  

So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you're probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It's just that simple. [emphasis mine]

When Warren lectures at business schools, he says, “I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches—representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all.”

He says, “Under those rules, you'd really think carefully about what you did and you'd be forced to load up on what you'd really thought about. So you'd do so much better.”

Again, this is a concept that seems perfectly obvious to me. And to Warren it seems perfectly obvious. But this is one of the very few business classes in the U.S. where anybody will be saying so. It just isn't the conventional wisdom. - https://old.ycombinator.com/munger.html

Treat your investments as sacred – more money is lost by getting into bad ideas than it is by missing out on good ideas. It’s easy to take a good idea and fool ourselves into thinking it’s a great idea. The 90% rule demands complete self-honesty. Remember, investments that meet the 90% rule are rare. It’s not easy to find exceptional opportunities. If we constantly find a lot of 90% ideas, we need to stop and think about how realistic and honest we are with ourselves. The higher the honesty, the more likely we will make wise investments. By following the 90% rule, we raise our investing standards, build a greater margin of safety, and can swiftly navigate an unpredictable future.

6 Investment Principles That Transform Fear & Uncertainty into Opportunity

Investing is all about the future. We invest cash today with an expected but ultimately uncertain amount of cash to be received in the future. The problem with the future is it’s largely unpredictable. Sure, we do our best to estimate and forecast what will happen, but ultimately, we invest in unknown and uncertain environments.

In a 2006 paper, Investing in the Unknown and Unknowable, Richard Zeckhauser described the challenges and opportunities of investing in unknown and unknowable environments. It’s a powerful article that explains why:

1.       Investors are overconfident in their ability to predict the future.

2.       Investors are reactionary and respond poorly to uncertainty and ambiguity.

3.       Investors should view the unknown as an opportunity, not a threat.

An uncertain future isn’t predictable, but we can prepare. Major investing mistakes occur at the extremes – whether a deep financial crisis or unconstrained market highs. Ambiguous and uncertain environments magnify poor decisions. These environments cause us to lose our rational, logical thoughts and rely on our primal, reactionary mental instincts. They goal is to understand how our mind reacts to unknown situations and design ways to turn these situations into opportunity. In essence, we should focus on preparing for uncertainty, not predicting uncertainty.

Investors should consider the following six lessons to help reframe unknown environments from fear to opportunity. As Richard stated, “Though investments are the ultimate interest, the focus of the analysis is how to deal with the unknown and unknowable.” Understanding the basics of the unknown allows us to make better decisions with less mental anguish. This can apply beyond investing to everyday life.

Principle #1: Understand When Traditional Financial Theory Fails

The essence of effective investment is to select assets that will fare well when future states of the world become known. When the probabilities of future states of assets are known, as the efficient markets hypothesis posits, wise investing involves solving a sophisticated optimization problem. Of course, such probabilities are often unknown, banishing us from the world of the capital asset pricing model (CAPM), and thrusting us into the world of uncertainty.

The real world of investing often ratchets the level of non-knowledge into still another dimension, where even the identity and nature of possible future states are not known. This is the world of ignorance. In it, there is no way that one can sensibly assign probabilities to the unknown states of the world. Just as traditional finance theory hits the wall when it encounters uncertainty, modern decision theory hits the wall when addressing the world of ignorance. -Zeckhauser’s Investing in the Unknown and Unknowable.

Traditional financial theories work well in normal environments, but break down at the extremes. It’s our preparation for extremes that enables us to navigate uncertain waters. Proper investing at extremes has more to do with emotional intelligence than financial expertise. It’s about making gut-wrenching decisions during financial chaos or irrational optimism. In theory, you should be following the same basic prudent investing rules regardless of the environment: rebalancing to your target portfolio, managing your liquidity and cash flows, and examining your risk profile. In a crisis, prudent behavior disappears as typical financial relationships break down. Our decision making becomes a random assortment of knee-jerk reactions and emotionally-fueled urges.

The practical solution is to first accept these situations will occur. Don’t stick your head in the sand. We can’t predict the causes or magnitudes of extreme events. But while prediction fails, preparation advances. We can prepare by understanding the investments we own so we can overcome our emotions and regain long-term, logical thinking. We can run through scenarios and stress our portfolio to extremes to figure out how much pain we can handle.

Finally, we can study historical events and learn lessons from other great investors who went through similar situations. There are two benefits. First, it’s comforting to know the best investors have gone through the same pain and faced the same impossible decisions that we will face. Second, we can actually borrow these investor’s techniques and tools for our own use. Many great investors lay out exactly how they approach unique situations. We can build a library of principles to help guide us during uncertain environments.

The second dreary conclusion is that most investors – whose training, if any, fits a world where states and probabilities are assumed known – have little idea of how to deal with the unknowable. When they recognize its presence, they tend to steer clear, often to protect themselves from sniping by others. But for all but the simplest investments, entanglement is inevitable – and when investors do get entangled they tend to make significant errors. -Zeckhauser’s Investing in the Unknown and Unknowable.

Ignoring the unknown is not an acceptable strategy. Delaying the recognition magnifies future errors. These errors can eliminate years of sound investing during normal times.

Remember the 2009 financial crisis. Investors who had done everything right up until then were caught off guard with the severity of the crisis. Many investors had excessive amounts of risk going into the crisis, and then compounded the problem by going to cash at the bottom. It’s not that investors forgot the basics of investing. It’s that they didn’t prepare for the “entanglements” in advance, so investors weren’t ready to make better choices.

Principle #2: To Capture Excess Investment Returns, Study The Unknown/Unknowable

Such idiosyncratic UU [unknown and unknowable] situations, I argue below, present the greatest potential for significant excess investment returns.

The first positive conclusion is that unknowable situations have been and will be associated with remarkably powerful investment returns. The second positive conclusion is that there are systematic ways to think about unknowable situations. If these ways are followed, they can provide a path to extraordinary expected investment returns. To be sure, some substantial losses are inevitable, and some will be blameworthy after the fact. But the net expected results, even after allowing for risk aversion, will be strongly positive. -Zeckhauser’s Investing in the Unknown and Unknowable.

Exceptional opportunities occur in volatile environments. These unknown and unknowable (Zeckhauser refers to them as “UU”) situations, can deliver significant opportunities. Investors scared of big price moves won’t have the fortitude to handle the occasional misses. Remember, the goal is to grow the total portfolio value over time. How many misses you have isn’t the important variable; it’s the totality and magnitude of your wins and losses that matter. Those who prefer no losses at all, often sacrifice significant total return growth verses investors who can handle some losses but allow their successful investments to more than compensate for those losses.

There is nothing wrong with a conservative, diversified portfolio that avoids higher return/higher risk investment situations. It’s important to understand where you have an advantage and where you don’t.

However, investors who excessively try to avoid volatility and uncertainty often buy and sell at the worst possible times, locking in losses to avoid mental pain.

Do not read on, however, if blame aversion is a prime concern: The world of UU is not for you. Consider this analogy. If in an unknowable world none of your bridges fall down, you are building them too strong. Similarly, if in an unknowable world none of your investment looks foolish after the fact, you are staying too far away from the unknowable. -Zeckhauser’s Investing in the Unknown and Unknowable.

Investors’ excessive desire to avoid looking foolish punishes their future returns. For example, it’s always hard to buy near the bottom since the trend looks so bad and the news flow is negative. And because investors tend buy early, they will certainly look foolish in the short term. This apparent foolishness compounds the already challenge of capturing exceptional opportunities. The ego’s desire to avoid looking wrong in the short term causes huge long-term pain. Short-term, “foolish” decisions can often be the most profitable, because a little early pain is necessary to capture the biggest opportunities.

But it would be surprising not to see significant expected excess returns to investments that have three characteristics addressed in this essay: (1) UU underlying features, (2) complementary capabilities are required to undertake them, so the investments are not available to the general market, and (3) it is unlikely that a party on the other side of the transaction is better informed. That is, UU may well work for you, if you can identify general characteristics of when such investments are desirable, and when not. -Zeckhauser’s Investing in the Unknown and Unknowable.

Let’s examine the 3 characteristics –

1.       UU Underlying features – Most UU (again, shorthand for unknown and unknowable) situations are a result of previous excesses being unwound in a rapid fashion. This can be an erosion of asset value at financial institutions (2009 crisis) or a shift in commodity supply & demand causing rapid price declines (2015 oil collapse). There are constant factors leading up to these crises. Easy money in the form of cheap debt or plentiful capital for investment. Excessive enthusiasm. Embracing new valuation paradigms with no substance. These environments begin with reasonableness but end up at extremes due to extrapolation, momentum, inadequate risk consideration, and a disregard for mean reversion and competition. There is usually a claim that this time is different.

2.       Complementary Capabilities – These capabilities refer to an investor’s ability to correctly analyze a UU situation. Although there is no guarantee of success, great investors have a few key attributes that convert a UU situation into a wise investment. First, they have the correct mental makeup and behavior regulation that enables logical and emotion-free analysis. Nothing is harder than trying to keep your head when a market is collapsing. Great investors acknowledge the uncertainty and emotion, but quickly engage their higher cognitive powers to establish agency over the situation. Highly complex investments don’t lend themselves to casual analysis by unprepared investors.

Second, they are subject matter experts on the specific market or security. Successful investing is not about blind investing into UU situations. Mean reversion works on average, but there is enough variation around the average which allows investors to blow up their portfolio. You don’t have to become the most knowledgeable and obtain a Ph.D, but you must know enough the tilt the odds in your favor. Not all investments that price at bargain levels will make it, and a few zeros can destroy your portfolio or cause you to lose faith in your process at the moment you need it most.

Finally, successful UU investors focus on risk control. Risk control is not about avoiding risk. Risk control is about thoughtfully approaching your portfolio with a sense of humility that offsets the natural tendency to overinvest or overconcentrate. Humility checks your ego and spreads your risk among several very attractive investments, rather than focus on one or two high conviction names. Well-known investors have been burned by overconfidence in their top ideas. When these go bad, they lose more than they can ever recover. Investing is always uncertain and unpredictable, and overconfidence will trap even the best investors.

3.       Information Asymmetry

Investors should pay close attention to the other investors in the market. If the situation favors the other side of the trade because they have an informational advantage, investors will likely lose. In some markets, such as IPOs, M&A transactions, art investing, etc, sophisticated/specialized investors will have a significant advantage. These markets are highly competitive and leave most investors as the sucker. However, UU situations are different. They are avoided because of the psychological pain and uncertain environment. All investors generally have the same informational level.

Principle #3: Judgment, Not Intelligence, Distinguishes Great Investors

Alas, few of us possess the skills to be a real estate developer, venture capitalist or high tech pioneer. But how about becoming a star of ordinary stock investment? For such efforts an ideal complementary skill is unusual judgment. Those who can sensibly determine when to plunge into and when to refrain from UUU investments gain a substantial edge, since mispricing is likely to be severe. -Zeckhauser’s Investing in the Unknown and Unknowable.

Judgement determines whether our investing intelligence is converted into money-making investments. Intelligence needs to be applied to the correct asset, at the correct price, at the correct time. Lots of smart, sophisticated investors execute poorly. For example, they buy good assets at the wrong price. They let emotions and hubris interfere with great thinking and end up buying or selling at the wrong time or in the wrong markets.

Note, by the way, the generosity with which great investors with complementary skills explain their successes – Buffett in his annual reports, Miller at Harvard, and any number of venture capitalists who come to lecture to MBAs. These master investors need not worry about the competition, since few others possess the complementary skills for their types of investments. -Zeckhauser’s Investing in the Unknown and Unknowable.

It’s an interesting thought – does Warren Buffet or other great investors fear giving away their secrets? No. They know the right combination of intelligence, temperance, humility, sound judgment, and courage may take decades to develop. Investors can’t turn on this ability when they want. It’s a mindset that needs deep cultivation and a lifetime of practice.

Principle #4: Overcoming Investor Biases Requires Thoughtful & Deliberate Training

Behavioral decision has important implications for investing in UU situations. When considering our own behavior, we must be extremely careful not to fall prey to the biases and decision traps it chronicles. Almost by definition, UU situations are those where our experience is likely to be limited, where we will not encounter situations similar to other situations that have helped us hone our intuition. -Zeckhauser’s Investing in the Unknown and Unknowable.

UU situations are not won by accumulating more facts or having a bigger spreadsheet. In these environments, there is an irreducible amount of uncertainty, no matter how much work and effort is applied. Clearly, you need to do your homework before investing. But many investors have the false idea that they can get rid of all uncertainty. They fool themselves with blind overconfidence. Our mind’s natural tendency is to eliminate any apparent uncertainty, through the stories we tell ourselves or our selective analytical approaches. UU situations require analysis and work, but ultimately success comes down to making a tough decision when the probability is deeply in your favor.

There are too many investor biases and mistakes to list here, but the important takeaway is to get comfortable with uncertainty. It’s a natural condition of successful investing. The goal is not uncertainty elimination, but uncertainty acceptance and management. If you accept uncertainty, you transform your outlook on uncertainty from a situation to fear to a situation to exploit.

Principal #5: Invest Where Others Neglect

The major fortunes in finance, I would speculate, have been made by people who are effective in dealing with the unknown and unknowable. This will probably be truer still in the future. Given the influx of educated professionals into finance, those who make their living speculating and trading in traditional markets are increasingly up against others who are tremendously bright and tremendously well-informed. -Zeckhauser’s Investing in the Unknown and Unknowable.

Just as in business, it often pays to invest in assets neglected by the competition. Fast growing ideas attract significant capital, reducing the expected returns and raising the risk profile. Investors who are late to the party will end up with higher risk and lower returns. For most investors, they are unlikely to be the first movers or early followers. They will arrive late, invest at the peak, and suffer significant losses.

The antidote is to go where there is less competition, little excitement, and significant uncertainty. These factors drive most investors away and create mispricings as prices significantly deviate from fundamentals.

Even sophisticated investors are likely to shy away from these areas.

First, their clients expect and prefer lower volatility and consistent returns, rather than volatile but higher returns. Clients want a smooth ride, and don’t tolerate excessive volatility from even the best managers.

Second, manager themselves feel pressure to gravitate towards opportunities that have a compelling narrative. Narrative-based investments are an easier sell to internal management and the public because they sound so good and have often performed well. But these attributes don’t correlate with future success, as competition and mean reversion often reverse any positive momentum and derail the narrative.

Finally, investments that appear certain today will often become uncertain, and vice versa. Uncertainty isn’t a permanent characteristic of any particular asset class. Uncertainty ebbs and flows based on investor emotions and economic conditions. Today’s uncertain areas may become more predictable as industries and companies adjust and adapt to new environments.

Because these environments are fluid and dynamic, they are always working toward an equilibrium condition. For example, when companies go bankrupt, those bankruptcies often give the remaining companies a stronger competitive position, higher market share, and a bigger share of the profits. So the conditions that cause uncertainty will usually correct itself as the markets and competitive economies adjust to new realities.

If you understand this process, you can be forward thinking and have a reasonable idea how these industries will evolve, even when it seems that the pain or uncertainty is unmanageable.

By contrast, those who undertake prudent speculations in the unknown will be amply rewarded. Such speculations may include ventures into uncharted areas, where the finance professionals have yet to run their regressions, or may take completely new paths into already well-traveled regions.

Similarly, the more difficult a field is to investigate, the greater will be the unknown and unknowables associated with it, and the greater the expected profits to those who deal sensibly with them. Unknownables can’t be transmuted into sensible guesses -- but one can take one’s positions and array one’s claims so that unknowns and unknowables are mostly allies, not nemeses. And one can train to avoid one’s own behavioral decision tendencies, and to capitalize on those of others. -Zeckhauser’s Investing in the Unknown and Unknowable.

Avoid depending on ultra-precise analysis as an attempt to remove uncertainty. The goal is to get close enough in your understanding of the situation to make an educated guess and position accordingly. Investors comforted by false precision are usually wasting time or fooling themselves.

Principle #6: Bet According To Your Advantage; But First Be Honest About Whether You Really Have An Advantage

…The greater is your expected return on an investment, that is the larger is your advantage, the greater the percentage of your capital you should put at risk…Most investors understand this criterion intuitively, at least once it is pointed out. But they follow it insufficiently if at all. The investment on which they expect a 30% return gets little more funding than the one where they expect to earn 10%. Investment advantage should be as important as diversification concerns in determining how one distributes one’s portfolio. -Zeckhauser’s Investing in the Unknown and Unknowable.

There should be some obvious intuition that higher conviction ideas with less risk and higher expected returns should have bigger positions in your portfolio.

In principle, I agree with that assessment. But there is a major assumption underlying this idea that must be true for this to work:

Do you actually have an advantage?

How do you know?

How do you know if you have correctly analyzed, vetted, and arrived at the correct conclusion?

What if you are just overconfident and mistaken?

How would you know until it’s too late?  

Anecdotally, I have heard several investors proclaim an investment as their #1 idea, only to see it actually end up as one of the worst ideas. I don’t believe an investor’s conviction level translates into above average returns. In fact, there may be an inverse correlation between the two. Anyone can pitch a compelling idea that promises all upside and no downside. It doesn’t mean it will happen.

If the difference between two ideas is significant enough, they should have different portfolio weights. But again, this all rests on the ability of the investor to be well calibrated to know when these differences really exist and when they are false.

Summary

Two rays of light creep into this gloomy situation: First, only rarely will his information put you at severe disadvantage. Second, it is extremely unlikely that your counterpart is playing anything close to an optimal strategy. After all, if it is so hard for you to analyze, it can hardly be easy for him. -Zeckhauser’s Investing in the Unknown and Unknowable.

As a final reminder, most investors you compete with are not playing an optimal strategy. Most are struggling, trying to figure out the best move in a complicated and uncertain world. Especially in periods of extreme stress, investors are likely to be on edge, forgetting the basic investing tenants and relying on emotion and gut feeling. By contemplating these principles, you have taken the initial steps to properly execute in the right investment situations. To be sure, you won’t get every decision correct. And yes, you may end up trading across from Warren Buffet or some elite hedge fund. But those situations will be the minority, especially if you adhere to these principles when thinking about the unknown and unknowable.

If you acknowledge and embrace the unknowable, you are better equipped to handle reality as it is – uncertain and unpredictable. By using wise judgement and training to overcome your inherent misconceptions, you outperform competing investors by leveraging your circle of competence and understanding when to make appropriate bets.

The 6 Principles in Review:

Principle #1: Understand When Traditional Financial Theory Fails

Principle #2: To Capture Excess Investment Returns, Study The Unknown/Unknowable

Principle #3: Judgment, Not Intelligence, Distinguishes Great Investors

Principle #4: Overcoming Investor Biases Requires Thoughtful & Deliberate Training

Principal #5: Invest Where Others Neglect

Principle #6: Bet According To Your Advantage; But First Be Honest About Whether You Really Have An Advantage

How Deep Work Can Transform Your Life: 7 Powerful Principles

Becoming exceptional is hard. The professional world is competitive, full of intelligent and ambitious people vying for the same top positions.

To make things more complicated, there isn’t one exact set of rules we can follow that guarantees success. Hundreds, if not thousands of books are published every year promoting magic formulas for success. But how many of these books create lasting change?

How many of us really achieve the success we expect?

Where do we go wrong?

What do we need to change if we don’t like the path we are on?

Do we practice becoming exceptional like we practice golf, triathlons, or public speaking?

No. We assume mastery is something that just happens. We go about it in a haphazard way while our frustration and struggles build when we don’t progress. We don’t treat mastery as a skill that can be improved. We just work hard and hope it happens.

Here’s the good news. There is a way to change your habits and behaviors that create lasting success and builds exceptional talent. The bad news is we must overcome significant mental and societal pressures to cultivate deep work.

If you are looking to make this shift from mediocre to exceptional, one of the best resources on creating success is Cal Newport. His blog, studyhacks.com, is a must read if interested in practical principles to achieve success. His latest book, Deep Work: Rules for Focused Success in a Distracted World, is my best recommendation to create permanent changes to do great things. (Note: All italicized quotes in this article are from Newport’s book, Deep Work)

The following 7 Principles, based on Cal’s book, can be used by anyone to improve the odds of becoming truly exceptional.

Principle 1: Identify Shallow vs. Deep Work

A lot can be explained by another type of effort, which provides a counterpart to the idea of deep work: Shallow Work: Noncognitively demanding, logistical-style tasks, often performed while distracted. These efforts tend to not create much new value in the world and are easy to replicate…To remain valuable in our economy, therefore, you must master the art of quickly learning complicated things. This task requires deep work.

To set the stage for this discussion, we need to define what deep work is. Here’s Cal’s definition:

 “Professional activities performed in a state of distraction-free concentration that push your cognitive capabilities to their limit. These efforts create new value, improve your skill, and are hard to replicate.”

Why is this important? Ask Cal mentioned, to remain valuable in this economy, master the art of quickly learning complicated things. Mastery comes from deep, deliberate work applied in a consistent and focused manner. We erroneously assume mastery will just come to us if we show up regularly or get enough experience. Certainly, we will gain some knowledge that way. But to become truly exceptional and stand above the rest, apply deep work principles.

Distinguish between shallow and deep work. If we can’t, we will never be able to properly transition into deep work. By minimizing or compartmentalizing shallow work, we create a maximum focus on deep work.

This compressed schedule is possible because I’ve invested significant effort to minimize the shallow in my life while making sure I get the most out of the time this frees up. I build my days around a core of carefully chosen deep work, with the shallow activities I absolutely cannot avoid batched into smaller bursts at the peripheries of my schedule. Three to four hours a day, five days a week, of uninterrupted and carefully directed concentration, it turns out, can produce a lot of valuable output.

Shallow work is inevitable. As much as we hate busywork, there is a certain amount we must manage. So how do we manage through? As Cal advises, we batch our shallow work into blocks where we do nothing else but get through as much as possible. Think of this like a sprint – as soon as we start, we embrace the distracted nature and work to accomplish as much shallow work as possible. As soon as the sprint is over, we stop the shallow work and re-engage in deep work.

Principle 2: Produce Good Work

The second reason that deep work is valuable is because the impacts of the digital network revolution cut both ways. If you can create something useful, its reachable audience (e.g., employers or customers) is essentially limitless—which greatly magnifies your reward. On the other hand, if what you’re producing is mediocre, then you’re in trouble, as it’s too easy for your audience to find a better alternative online.

Because of social media and the internet, anything we do can be quickly disseminated throughout the world. This is the key to building our brand and reputation as a rare and exceptional talent. When we create valuable writing, advice, art, etc, we can share the work with the world. The more people that benefit from what we do, the more valuable we become and the more we control our destiny.

The flipside is also important. Our competition – especially people vying for your job, have the same opportunity to share valuable work. Competition has become meritocratic. We are judged on our actual ability rather than where we went to school or who we know. Anyone in the world can compete with us. There are no geographical or physical boundaries that apply. The brutal competitive environment just got tougher and wont get any easier for us.

The longer you wait to accept this the further back you will put yourself. Eventually, competition will arrive and we will be separated by who can deliver and prove their value and who can’t.

In a seminal 1981 paper, the economist Sherwin Rosen worked out the mathematics behind these “winner-take-all” markets. One of his key insights was to explicitly model talent—labeled, innocuously, with the variable q in his formulas—as a factor with “imperfect substitution,” which Rosen explains as follows: “Hearing a succession of mediocre singers does not add up to a single outstanding performance.” In other words, talent is not a commodity you can buy in bulk and combine to reach the needed levels: There’s a premium to being the best.

There really is a benefit to becoming exceptional at one thing. You don’t have to master every field or become an expert in everything. That’s impossible. The world will reward you if you are exceptional at one thing.

Just being “good enough” doesn’t set you apart. You are still a commodity and are expendable.

Two Core Abilities for Thriving in the New Economy

1. The ability to quickly master hard things.

2. The ability to produce at an elite level, in terms of both quality and speed.

As Cal states, once we master hard things, we then have to prove our mastery. If we keep our mastery inside our head and never tell anyone, no one will ever know. It’s our responsibility to show the world our talents and value. No one else will make sure we get what we deserve.

We see this with college graduates. Just because they have a degree, graduates assume the world will recognize their genius and reward them appropriately. But degrees are becoming totally irrelevant. 20 years ago, it was safe to assume that a college degree led to differentiated skills. It was so much rarer then as it is now. With the proliferation of colleges and the ease of getting a degree, employers are rightfully skeptical of new graduates providing value from day one.

It doesn’t matter where you are in your career. We must take the initiative and prove to world what we can do.

Once you do the hard work of becoming exceptional, don’t neglect to share your work.

Now consider the second core ability from the list shown earlier: producing at an elite level. If you want to become a superstar, mastering the relevant skills is necessary, but not sufficient. You must then transform that latent potential into tangible results that people value.

Principle 3: Utilize Deep Work to Magnify Results

This brings us to the question of what deliberate practice actually requires. Its core components are usually identified as follows:

(1) your attention is focused tightly on a specific skill you’re trying to improve or an idea you’re trying to master;

(2) you receive feedback so you can correct your approach to keep your attention exactly where it’s most productive.

Most people understand the first requirement, even though it’s often hard to put into practice. Deep work requires undivided and sustained attention to your skill. It’s an unnatural habit and mindset that doesn’t come easy. If you struggle at first to maintain focus, don’t give up. Today’s environment doesn’t favor deep work. You are not alone in this struggle. If needed, start with 15 minutes of focused activity, and then aim to increase that by 5 minutes the next time you study. Track your progress on your calendar. Tracking provides a solid record of your progress and provides valuable feedback on your progression.

Don’t think you can switch focus every 5 minutes over the course of a couple hours. This effort needs to be concentrated in one time period. As Cal stated, “…though Grant’s productivity depends on many factors, there’s one idea in particular that seems central to his method: the batching of hard but important intellectual work into long, uninterrupted stretches.”

It takes time to get into the flow with deliberate practice. It’s almost like we need a mental warmup like we would with a physical workout. If we only work for 5 or 10 minutes at a time and then switch our focus, we have to keep starting over every time we re-engage. So make it a habit to start once and continue for 30-60 minutes.

The second requirement is typically missed. We assume by showing up and working hard we will achieve success. But attaining mastery requires a different approach. This approach includes objective and unbiased feedback. Feedback delivers guidance and suggestion and what needs improvement and how to adjust. Without feedback, you are operating blind – you are just showing up and hoping that your actions are leading to improvement. Feedback connects the actions you take with the results you get. If there is no link, you can’t be sure how much success you are achieving and the source of that success.

If you remember one formula, remember this from Cal:

High-Quality Work Produced = (Time Spent) x (Intensity of Focus)

We need to clarify one possible point of confusion. We haven’t said anything about increasing the quantity of hours worked; we have focused just on quality. Quality is reflected in the intensity, focus, and deliberate nature of our practice. While we may need to allocate more time to our skill, first look to optimize the time we already invest. That alone should vault us to the top echelons of our skill. Afterwards, we can add in more time if necessary. But given our competing schedules, it’s not always possible to add more time. So remember, it’s always quality over quantity - focus on improving the time you already spend (quality) before thinking about adding more time (quantity). As Cal mentions below, top students don’t become best just by working longer, they work smarter.

The best students understood the role intensity plays in productivity and therefore went out of their way to maximize their concentration—radically reducing the time required to prepare for tests or write papers, without diminishing the quality of their results.

Principle 4: Design Your Environment to Enable Deep Work

The Principle of Least Resistance: In a business setting, without clear feedback on the impact of various behaviors to the bottom line, we will tend toward behaviors that are easiest in the moment.

Busyness as Proxy for Productivity: In the absence of clear indicators of what it means to be productive and valuable in their jobs, many knowledge workers turn back toward an industrial indicator of productivity: doing lots of stuff in a visible manner.

Cal’s two principles highlight a major roadblock against deep work. Our environments, especially professionally, are poorly designed to enable deep work. It’s a constant barrage of emails, interruptions, and scattered meetings. When we show up to work and attempt to “willpower” our way into deep work, we may find some short-term success, but will ultimately succumb to behaviors and actions that are the easiest and offer the least resistance. Instead of toughing this out, we need to rethink how we design our work environment to enable deep work, and not shallow work, to be the default mode of action.

As Cal stated, without clear feedback, we can’t separate deep work from shallow busywork. When we deliberately set up practice that delivers immediate feedback and results in clear, unambiguous progress indicators, we have begun engaging in deep work. There is an easy test to determine if work is shallow or deep:

Does our work:

1)     provide feedback?

2)     provide verified, measurable progress?

For example, email provides no feedback and no measurement of getting better at anything.

However, writing and publishing an article through an email list does – people will respond with comments and feedback. You can track open rates and other metrics to judge readership progress. The goal is to always engage in some project that allows you to receive feedback and measurable results.

Testing is another great example. For example, if you are studying for your CPA exam, practice tests provide both feedback (you’re able to compare your answer to the correct answer, often with explanations showing where you went wrong) and measurement (you can track your scores over time and see an unbiased measurement of your progress.

If you believe in the value of depth, this reality spells bad news for businesses in general, as it’s leading them to miss out on potentially massive increases in their value production. But for you, as an individual, good news lurks. The myopia of your peers and employers uncovers a great personal advantage. Assuming the trends outlined here continue, depth will become increasingly rare and therefore increasingly valuable.

Not only does deep work provide better engagement, it provides a huge advantage over your competition. The benefits are double. Deep work provides more long-term satisfaction on a personal level, and provides a sustainable competitive advantage in your career.

As Cal states, “Human beings, it seems, are at their best when immersed deeply in something challenging.”

Principle 5: Schedule Your Day

Seinfeld began his advice to Isaac with some common sense, noting “the way to be a better comic was to create better jokes,” and then explaining that the way to create better jokes was to write every day. Seinfeld continued by describing a specific technique he used to help maintain this discipline. He keeps a calendar on his wall. Every day that he writes jokes he crosses out the date on the calendar with a big red X. “After a few days you’ll have a chain,” Seinfeld said. “Just keep at it and the chain will grow longer every day. You’ll like seeing that chain, especially when you get a few weeks under your belt. Your only job next is to not break the chain.”

As the Seinfeld lesson shows, showing up every day, in a consistent manner, can produce incredible results. But how can you ensure that you show up every day? We’ve all resolved to stick to a diet or workout plan, but most of us fail after only a few days. How can we approach this differently?

One idea is to schedule out your day hour by hour. This may sound extreme, but top performers use specific schedules to thoroughly plan their day. Without an exact schedule, you simply fill in your day with whatever is convenient. Sure, there might be good days where you engage in deep work. But most days end up like we described in lesson 6. You fill your day with the activities that are the most painless, not the most productive. Deep work can be painful because it’s intense and focused. It takes a certain amount of dedication to commit the energy to focus. It doesn’t appear naturally or easily, which is why we must schedule our deep work sessions.

I should admit that I’m not pure in my application of the journalist philosophy. I don’t, for example, make all my deep work decisions on a moment-to-moment basis. I instead tend to map out when I’ll work deeply during each week at the beginning of the week, and then refine these decisions, as needed, at the beginning of each day (see Rule #4 for more details on my scheduling routines). By reducing the need to make decisions about deep work moment by moment, I can preserve more mental energy for the deep thinking itself.

At the beginning of each week, we map out our Monday through Friday hour by hour. This won’t be perfect. Changes are to be expected as the week won’t unfold exactly like we planned it. But this schedule gives us the best chance to prioritize deep work time instead of trying to fit it in. 

There is a popular notion that artists work from inspiration—that there is some strike or bolt or bubbling up of creative mojo from who knows where… but I hope [my work] makes clear that waiting for inspiration to strike is a terrible, terrible plan. In fact, perhaps the single best piece of advice I can offer to anyone trying to do creative work is to ignore inspiration. In a New York Times column on the topic, David Brooks summarizes this reality more bluntly: “[Great creative minds] think like artists but work like accountants.”

Scheduling doesn’t reduce our creativity or spontaneity. Scheduling deep work and creativity reinforce one another. By blocking off time for deep work, we stop worrying about how we will get everything done. Instead, we build contentment by actively choosing our schedule and not letting life choose our priorities.  

[J.K] Rowling’s decision to check into a luxurious hotel suite near Edinburgh Castle is an example of a curious but effective strategy in the world of deep work: the grand gesture. The concept is simple: By leveraging a radical change to your normal environment, coupled perhaps with a significant investment of effort or money, all dedicated toward supporting a deep work task, you increase the perceived importance of the task. This boost in importance reduces your mind’s instinct to procrastinate and delivers an injection of motivation and energy.

Copy Rowling’s habit of using a grand gesture – any environment or ritual that gets you in the right mindset to create deep work. Simplicity is key. A separate, dedicated room just for deep work. A sacred time, off limits to other activities. It can be working in the same coffee shop or library. Any activity or environment that triggers the mental state of deep work is fine. Don’t overthink this.

Principle 6: The 4 Disciplines of Deep Work

Cal referenced the book, The 4 Disciplines of Execution, which provided 4 disciplines to enhance deep work. Implement these immediately in your routines.

Discipline #1: Focus on the Wildly Important

As the authors of The 4 Disciplines of Execution explain, “The more you try to do, the less you actually accomplish.” They elaborate that execution should be aimed at a small number of “wildly important goals.”

If you try to do everything you will end up doing nothing. It’s hard to cutoff of choices and not do certain things. To become exceptional, you must focus your activities on the elite few.

Warren Buffet’s Advice

Warren Buffet once discussed career objectives with his personal pilot, Mike Flint. Flint wrote down his 25 top goals and Buffet had him circle his top 5. Flint described how he would begin working on his top 5 right away, but would work on the other 20 when he found time.

Buffet quickly admonished Flint, saying, “No, you’ve got it all wrong, Mike. Everything you didn’t circle became your Avoid-At-All-Cost list. No matter what, these things get no attention from you until you’ve succeeded with your top 5.”1

As Buffet makes clear, avoid spreading your attention to wide. You can’t do everything and attempting to do so will ensure failure.

Discipline #2: Act on the Lead Measures

Lead measures, on the other hand, “measure the new behaviors that will drive success on the lag measures.” In the bakery example, a good lead measure might be the number of customers who receive free samples…In other words, lead measures turn your attention to improving the behaviors you directly control in the near future that will then have a positive impact on your long-term goals…For an individual focused on deep work, it’s easy to identify the relevant lead measure: time spent in a state of deep work dedicated toward your wildly important goal.

Always measure the most direct actions you are taking towards your goal. If you are writing, it is time spend in deep writing. If it’s sports, it’s time spent in deep practice. These are the lead measures that will produce exceptional results. Focus on consistent progress on your lead measures, and you won’t have any trouble reaching your long-term goals.

Discipline #3: Keep a Compelling Scoreboard

As each week progressed, I kept track of the hours spent in deep work that week with a simple tally of tick marks in that week’s row. To maximize the motivation generated by this scoreboard, whenever I reached an important milestone in an academic paper (e.g., solving a key proof), I would circle the tally mark corresponding to the hour where I finished the result.* This served two purposes. First, it allowed me to connect, at a visceral level, accumulated deep work hours and tangible results. Second, it helped calibrate my expectations for how many hours of deep work were needed per result. This reality (which was larger than I first assumed) helped spur me to squeeze more such hours into each week.

A scorecard keeps an accurate tally of your deep work hours and tracks your major milestones. You never want to keep this in your head. A written record of your effort and progress is powerful. It forces you to track and analyze how well you are really doing. If you don’t write it down, it doesn’t count.

Discipline #4: Create a Cadence of Accountability

The 4DX [The 4 Disciplines of Execution] authors elaborate that the final step to help maintain a focus on lead measure is to put in place “a rhythm of regular and frequent meetings of any team that owns a wildly important goal.” During these meetings, the team members must confront their scorecard, commit to specific actions to help improve the score before the next meeting, and describe what happened with the commitments they made at the last meeting.

Your own personal accountability should be measured weekly by diligently assessing your progress and noting the success and failures. This exercise is meant to inform you of repeated, consistent roadblocks that hinder your progress. It’s not a judgment, it’s a reflection. It’s not meant to be personal, just to keep you unbiased and objective.

Principle 7: The Difference Between “What” vs. “How” (or why so much advice is worthless)

There is, however, a lesser-known piece to this story. As Christensen recalls, Grove asked him during a break in this meeting, “How do I do this?” Christensen responded with a discussion of business strategy, explaining how Grove could set up a new business unit and so on. Grove cut him off with a gruff reply: “You are such a naïve academic. I asked you how to do it, and you told me what I should do. I know what I need to do. I just don’t know how to do it.” As Christensen later explained, this division between what and how is crucial but is overlooked in the professional world. It’s often straightforward to identify a strategy needed to achieve a goal, but what trips up companies is figuring out how to execute the strategy once identified.

My biggest critique of self-help and management books is the focus on the “what” instead of the “how”. We all know we should be better leaders, more effective managers, more inspirational, more forward-looking, and so on. The challenge is how to actually do that in real life. Most advice never advises you on how to actually become a better leader or a master of your skill. They are full of clichés and vague one-liners. They never give you step-by-step instructions on practical steps. They seem to think by knowing what you need to do, you will just figure out how to do it. That’s exactly where progress stops. Most of the time, we know exactly what we need to do. It’s how to do it that’s the problem.

The goal of this article was to convert the “what” (7 principles) into the “how” (practical implementation steps). Here’s a quick summary of the 7 Principles:

Principle 1: Must Identify Shallow vs. Deep Work

Principle 2: Produce Good Work

Principle 3: Utilize Deep Work to Magnify Results

Principle 4: Design Your Environment to Enable Deep Work

Principle 5: Schedule Your Day

Principle 6: The 4 Disciplines of Deep Work

Principle 7: The Difference Between “What” vs. “How” (or why so much advice is worthless)

1Story from http://jamesclear.com/buffett-focus.

The Influence of Crowd Psychology on the Investor

In 1895, Gustave Le Bon published his best-known work, The Crowd: A Study of the Popular Mind. At the time, Le Bon enhanced the understanding of crowd psychology by researching and proposing several theories of how our beliefs and actions are altered in a “crowd” state.

How can a book from 1895 be useful to investors today? The basic idea is that our minds have not changed over the last 100 years. We still respond to the same emotions and biases as our ancestors. We repeat the same mistakes, generation after generation.

The influence of the crowd has never been more relevant. We must protect our mind from the opinions and ideas we accept. The information deluge is constant. It’s a fuzzy, almost imperceptible line to separate our own opinions from the opinions of the masses. That battle is consistently lost by unprepared investors who let their guard down when making investment decisions. 

Because we, as humans, are susceptible to overconfidence, we assume the crowds have no influence on our mind. We are too confident - it’s always other people’s problem, not ours. We are way too smart to be influenced by crowds.  I wish that were true, but studies clearly indicate otherwise.

How do we fight against becoming the “crowd” and learn to combat the frivolous and dangerous ideas?

Based on Le Bon’s work, I have created 8 lessons to prepare your mind against crowd behavior. (Note: all quotes attributable to Le Bon’s work, The Crowd)

It’s not an easy or painless endeavor. As Le Bon stated, “Science promised us truth, or at least a knowledge of such relations as our intelligence can seize: it never promised us peace or happiness.”

Understanding crowd psychology is not comfortable. We might not like the journey, but ignoring science dooms us to forever remaining in the crowd.

1.       The Struggle to Maintain Independence

It is only by obtaining some sort of insight into the psychology of crowd that can be understood how slight is the action upon them of laws and institutions, how powerless they are to hold any opinions other than those which are imposed upon them, and that it is not with rules based on theories to pure equity that they are to be led, but by seeking what produces an impression on them and what seduces them.

The goal is to understand how a crowd imposes its will on our minds. The first step is always understanding the process. The second step is creating a habit or framework to counter crowd effects.

We see that the disappearance of the conscious personality, the predominance of the unconscious personality, the turning of feelings and ideas in an identical direction by means of suggestion and contagion, the tendency to immediately transform the congested ideas into acts. These receive the principal characteristics of the individual forming part of a crowd. He is no longer himself, but has become an automaton who has ceased to be guided by his will.

Whenever we self-identify with a crowd, whether consciously or unconsciously, we strip away our ability to remain objective and rational. It’s evident in politics and religion. Ever try to have a logical political or religious debate? How quickly did it devolve into an anecdotal argument full of personal attacks and red herrings? Most people quickly move into defensive positions and start to defend their identities, rather than the argument. Once that happens, all reason disappears and no progress is made.

The crowd is at the mercy of all external exciting causes, and reflects their incessant variations. It is the slave of the impulses which it receives. Isolated individuals may be submitted to the same exciting causes as a man in a crowd, but as his brain shows him the in advisability of yielding to them, he refrains from yielding. The truth may be physiologically expressed by saying the isolated individual possesses the capacity of dominating his reflex action, while crowd is devoid of this capacity.

Remember, the crowd doesn’t seek the truth; it’s in constant search of excitement, novelty, and reward. If you understand that, you are prepared to understand events with a free mind. By remaining outside the crowd, you retain your capacity to evaluate the situation independently.

It’s never a problem to agree with the crowd, as long as you come to that decision through independent means. And doing that is never easy.

2.       Excitement and Novelty Drive Belief

The exciting causes that may act on crowds been so buried, and crowds always opening them, crowds are in consequence extremely mobile. This explains how it is that we see them pass in a moment from the most bloodthirsty ferocity the most extreme generosity and heroism.

When financial crowds operate in extreme directions, the market moves defy logic. What excited a crowd one day is erased with a terrifying reversal in sentiment the next day. These actions are unpredictable and wild. Although we try in vain to understand what is happening, it’s sufficient to attribute these moves to crowd behavior. Don’t waste time and energy trying to dissect the “meaning” of what these moves mean. There is no meaning, other than investors are all behaving under the spell of crowd psychology. While other factors, like leverage, enhance these effects, the root cause is always the crowd on one side of the trade.

They may be animated in succession by the most contrary sentiments, but they will always be under the influence of the exciting causes of the moment…Still, though the wishes of crowds are frenzied they are not durable. Crowds are as incapable of willing as of thinking for any length of time.

On the positive side, the extreme swings don’t last. Fundamentals eventually matter, and the crowds that operate irrationally eventually run out of assets to sell or run out of money to buy. The best course of action is remaining patient and vigilant. These are the opportunities to take advantage of the crowd, by using their instability against them.

3.       Crowd Beliefs Shut Down Thinking

A crowd is not merely impulsive and mobile. Like a savage, it is not prepared to admit that anything can come between its desire and the realization of its desire. It is less capable of understanding such an intervention, a consequence of the feeling of irresistible power given it by its numerical strength. The notion of impossibility disappears from the individual in a crowd.

Investors during the 2000 tech bubble and the 2006 housing bubble understand why the notion of impossibility disappears from the investment crowd. During those bubbles, tech and housing assets were viewed as can’t miss opportunities, and no amount of rational thinking could prevent investors from believing it was different this time. These assets couldn’t fail because of new paradigms, due to the Internet emergence in 2000 or the unending real estate boom in 2006. Owning these assets and watching them rise reinforced the belief that these assets couldn’t go wrong. But they did, and in a big way.

The improbable does not exist for crowd, it is necessary to bear the circumstance well in my to understand the facility with which are created and propagated the most improbable legends and stories…The simplicity and exaggeration of the sentiments of crowds have for result that a throng knows neither doubt nor uncertainty.

Legends and stories, not facts and data, drive investment booms and busts from healthy to extreme. It’s the stories that convince us of the invincibility and permanence of new ideas. During a bull market, our minds run wild with the possibilities of fantastic gains and newfound wealth. During a crisis, we believe everything is going to zero and assume permanent financial destruction.

The commonality behind both situations is our reliance on stories, rather than relying on factual research and historical lessons. We quickly dismiss any logical approach, because we’ve attached our opinions to the movement of the crowd.  

Whether the feelings exhibited by a crowd be good or bad, they present the double character being very simple and very exaggerated. On this point, as on so many others, and individual in a crowd resembles primitive beings.

We become primitive, in the sense we abandon our developed cognitive processes and let our reptilian brain direct our actions. Our primitive brain was well-designed for living 2,000 years ago, but has not adapted to the modern financial world. Because fear and greed operate on our basic, primitive minds, we must deliberately engage our higher cognitive mind to think clearly.

4.       Emotion Dominates Facts and Evidence

An individual may accept contradiction and discussion; a crowd will never do so.

The chain of logical argumentation is totally incomprehensible to crowds and for this reason is permissible to say that they do not reason or that they reason falsely and are not to be influenced by reasoning.

Crowds dismiss all alternative explanations and contradictory evidence. There are excuses for everything, and no amount of facts or reason will persuade a crowd.

Evidence may be accepted by an educated person, but the convert will be quickly brought back by his unconscious self to his original conceptions. See him again after the lapse of a few days and he will put forward a fresh his old arguments and exactly the same terms.

We can educate, train, and then educate some more, but still never escape the grasp of the crowd. It takes persistent training to re-wire our brains to instinctively recognize and fight the influence of the crowd. It doesn’t happen overnight.

I’ve personally experienced and seen others attempt to change behavior by just adding more information and assuming that will change behavior. Because our behavior is based on cognitive processes evolved over millennia, it’s going to take more than new info to make the change. It’s about using new info to transform habits into permanent behavior change.

That’s why you see investors make the same, repeated mistakes. We can spend all day convincing people of one thing, only to have them revert back a day later. The reason is two-fold. It’s the brain’s way of resisting change and reflects our ill-designed attempts to convert behavior. Permanent, long-term behavior modification requires repeated exposure to live training. Anything else is futile.

A longtime is necessary for ideas to establish themselves in the minds of crowd, but just as long a time is needed for them to be eradicated. This reason crowds, as far as ideas are concerned, are always several generations behind learned men and philosophers.

When we think of “learned men and philosophers” within investing or business, we gravitate toward the those who have proven their investing acumen over decades. JP Morgan, John Rockefeller, Andrew Carnegie, Ben Graham, Warren Buffet. All exceeded their generation by operating outside of the normal crowd state. The goal is to incorporate the lessons of the historic greats and operate with different principles than the crowd. It’s not enough to know different information. We must operate with a different set of principles than the crowd: independence, grit, intelligence, foresight, contrarianism, and persistence.

It is not than the facts and themselves that strike the popular imagination, but the way in which they take place in our brought under notice. The epidemic of influenza may very little impression on the population because they happened a little at a time, as opposed to one giant event that would’ve caused an uproar among the population.

The hardest beliefs to challenge can be the most non-obvious. Incorrect beliefs that have been learned gradually often lack the vividness that would normally cause us to re-examine those beliefs.

5.       Strong Beliefs are Fine, But be Open to Change

A person is not religious solely when he worships a divinity, but when he puts all the resources of his mind, the complete submission of his will, and the whole sold ardor of fanaticism at the service of a cause or an individual becomes the goal and guide of his thoughts and actions.

It’s fine to have beliefs, and strong beliefs at that. But all beliefs need at least 3 qualities:

1.       Evidenced based – valid, fundamental data should support your beliefs. Data is not always perfect and is never guaranteed, especially when thinking about the future. But there is no room for mythical or untested beliefs to drive investing decisions.

2.       Open to modification or reversal – strongly held beliefs should be changed when the weight of the evidence tips to the side of change. Beliefs should be held tentatively, ready to be changed when sufficient data/evidence is presented. Some beliefs may change daily (for example, because prices move daily, what is a terrible deal at one price is a great deal at another price) or may be rarely change (the idea that investing and saving for the future is a good thing). There’s no easy answer to this, other than to evaluate each belief on its own when new evidence is presented.

3.       Separate beliefs from your identity – if you attach beliefs to your identity, personality, or other personal trait, you run the risk of keeping beliefs not because they are correct, but because you become more interested in defending your ego and reputation. For example, if you always self-identify as bullish and optimistic on the stock market, it’s challenging to change your mind when the market is overvalued, because you have created a reputation and identity as someone who is perpetually bullish. It’s hard to have the guts to change your mind when your identity is something else.

You’ve created cognitive dissonance when your identity is telling you one thing (buy stocks) and the evidence is telling you another (sell stocks). The identity almost always wins, because our minds have a bigger interest in protecting our identity than searching for the truth. This is deadly for investors. Don’t take permanent stances in investing. Don’t create reputations or identities that make it painful to change your mind.

The masses have never thirsted after truth. They turn aside from evidence that is not to their taste, preferring to deify error, if error seduced them. Whoever can supply them with delusions is easily their master, whoever attempts to destroy their illusions is always their victim.

Many investors are eternally searching for the magic formula or guaranteed path to riches. They spend thousands of dollars on programs and systems that supposedly “reveal” the inside secrets of investment success. When viewed through a logical, rational lens, these claims are ludicrous and insane. But when viewed through the “crowd” lens, these programs make perfect sense. They appeal to investor’s desire for a can’t miss system, no matter how incredulous.

Investors must recognize when they fall under the spell of delusional, yet seductive systems that promise riches. It’s an inherent bias we all need to fight, and the minute we let our guard down, we succumb to our primal, crowd-based motives.

The experiences undergone by one generation are useless, as a rule, for the generation that follows, which is the reason why historical facts, cited with a view to demonstration, serve no purpose.

There are several reasons why investors forget the lessons of the past.

1.       We assume the people in the past were unsophisticated/unintelligent. We will never make those same mistakes. Wrong. While we have certainly advanced as a society, poor investing decisions in the past were usually never the result of a relative disadvantage in IQ or decision making. While we may know more today, we are also making decisions in a world that is more complicated and uncertain than it was in the past. In absolute terms, we may have an edge, but we are playing a more complex investing game. We are in a tougher environment, so we are relatively no better off.

2.       Hindsight is 20/20 – With the benefit of hindsight, we create all sorts of reasons why we wouldn’t have made those same mistakes. But it’s always obvious in retrospect, never in real-time. If you think it’s so easy, write down some can’t miss ideas today, and track those over a course of 3-5 years. Chances are you will have as many misses and wins, if not more misses. It’s a simple experiment to prove how hard it is to move hindsight into foresight.

3.       We assume the environment today is more predictable because we have access to more immediate information. Yes, we do have more information, and some of it is extremely valuable. However, that information comes with a lot of noise (data or information that has no predictive use or functional utility). And the catch is, it’s difficult to separate those two groups. We often get a mess of data and try to figure out what is news and what is noise. There’s never a clear answer, because what is useful in one environment is useless in another. You must be very clear about what edge you have and understand your circle of competence. Once you start to drift outside your core competence, you make all sorts of mistakes, including mistaking noise for news.

 6.       Understand the Psychological Tricks Preying on Your Mind

We’ve already discussed the problems dealing with unpredictable and complex investment situations. But there is even more trouble for us.

The financial industry promises to help investors navigate the complex investment world. Of course, they don’t expect to do that for free. It’s a lucrative industry that spawns many charlatans, con men, and promotors who want a slice of our wealth in exchange for bogus market-beating systems and hot stock tips.

These are both people and corporations full of bad advice and misdirection. To defeat them, you need know the tricks they play. Le Bon suggests several situations and triggers to watch for to understand when you are being pulled in the wrong direction.

We have already shown the crowd or not to be influenced by reasoning, and can only comprehend rough and ready associations of ideas. The orators who know how to make an impression upon them always appealing consequence to their sentiments and never to the reason. The laws of logic have no action on crowds.

The first idea: understand they always appeal to emotion, not reason. They sell with stories and dreams, not verified facts and evidence. If they based their approach on raw evidence, 1) their performance/client results look terrible, and 2) it does little to inspire wealth and riches when looking at cold numbers. They need to get you excited to get rich, or at least distract you from the flaws and risks in their argument. So always separate fact from story.

Given to exaggeration and its feelings, a crowd is only impressed by excessive sentiments. An orator wishing to move a crowd must make an abusive use of violent affirmations. To exaggerate, to affirm, to resort to repetitions, and never to attempt to prove anything by reasoning or methods of argument well known to speakers at public meetings.

It is terrible at times to think of the power that strong conviction combined with extreme narrowness of mine gives a man possessing prestige. It is nonetheless necessary that these conditions should be satisfied for man to ignore obstacles and display strength the will and a high measure. Crowds instinctively recognize and men of energy and conviction the Masters they are always in need of.

Two elements persuade a crowd. Strong conviction and extreme narrowness. Strong conviction delivers an overwhelming aura of superiority and challenges your ability to think independently, even if the conviction is baseless. Extreme narrowness reinforces that there is only one solution and path forward. It leaves no room for alternative explanations or doubt.

7.       How False Beliefs Spread

The first is that as the old beliefs are losing their influence to a greater and greater extent, they are ceasing to shape the ephemeral opinions of the moment as they did in the past. The weakening of general beliefs clears the ground for crop of haphazard opinions without a past or future.

As economic and investment cycles progress, investors abandon common-sense, fundamental principles and gravitate towards riskier, crowd-like behavior. There is always a rationale why the old beliefs don’t matter and the new ideas must be the new answer.

A second reason is that the power of crowds being on the increase, and this power being less and less counterbalance, the extreme ability of ideas, which we have seen to be a peculiarity of crowds, can manifest itself without let or hindrance.

As ideas spread, they build momentum and a cult-like power that begins to defy reason and logic. Unfortunately, these ideas don’t need any extra push when they start to spread. They build their own momentum through the explosive exponential power of networks.

8.       Why We are Doomed to Repeat Our Mistakes

Judging by the lessons of the past, and by the symptoms that strike the attention on every side, several of her modern civilizations have reached that phase of extreme old age which precedes decadence. It seems inevitable that all peoples should pass through identical phases of existence, since history is so often seem to repeat its course.

One of Le Bon’s final lessons is the idea that humans continue to repeat the same mistakes of the past. No matter how much we improve our understanding, intelligence, or technology, we have ingrained biases and tendencies that we can never permanently overcome. Due to laziness and ignorance, we assume these lessons don’t apply to us, because it’s so hard to create an outside, objective filter to view our own actions. Even though we can’t remove them, we can circumvent and avoid the consequences by deliberately understanding the underlying causes. The key word is deliberate, because just adding more information will not work. We need a conscious effort to understand the historical lessons and design ways of countering the effects of crowd-like behavior.

8 Principles to Become an Exceptional Performer

We all experience the joys and frustrations of learning a new skill. From athletics, to music, to our professional lives, we strive to master our craft and improve our ability. Weekend golfers try to take strokes off their game, amateur musicians strive to create new music, and doctors work to better care for their patients.

Some have highly specific goals in mind and devote constant effort to improvement. Others may take a relaxed, less intense approach. Both groups encounter similar frustrations along the way. Why do we often plateau and struggle after a period of time? Why do some people improve at a faster rate than others?

Given our busy lives and competing demands, how can we best improve from average to exceptional?

K. Anders Ericsson has spent his professional life figuring out what separates elite performers from the average masses. As a Florida State psychology professor and author of Peak: Secrets from the New Science of Expertise, Ericsson is the go-to expert behind the principles of exceptional performance. His results and lessons are counterintuitive. What doesn’t matter is innate talent or genetics. What does matter is the deliberate and focused attention we apply to our practice and training.

To preview, we have complete control of our ability to learn any new skill. However, society reinforces the myth that experts are born and not made, making deliberate effort a fruitless endeavor. It’s a mindset instilled when we are young. We rationalize poor performance and deflect personal responsibility. Instead of accepting responsibility, we blame a lack of talent.

Ericsson’s research has proven this wrong. Let’s explore how to apply 8 principles, based on Ericsson’s work, to become an elite performer.

1.       Your Abilities are not Fixed

…both the brain and the body retain a great deal of adaptability throughout adulthood, and this adaptability makes it possible for adults, even older adults, to develop a wide variety of new capabilities with the right training…If you talk to these extraordinary people, you find that they all understand this at one level or another. They may be unfamiliar with the concept of cognitive adaptability, but they seldom buy into the idea that they have reached the peak of their fields because they were the lucky winners of some genetic lottery. They know what is required to develop the extraordinary skills that they possess because they have experienced it firsthand. - Peak: Secrets from the New Science of Expertise

The first idea is the belief that your abilities are not fixed. Once you believe you can influence and change yourself, you see struggles as learning opportunities, not judgments on your self-worth. You must develop the habits and routines to transform struggles into learning lessons to build permanent change.

But we now understand that there’s no such thing as a predefined ability. The brain is adaptable, and training can create skills—such as perfect pitch—that did not exist before. This is a game changer, because learning now becomes a way of creating abilities rather than of bringing people to the point where they can take advantage of their innate ones. In this new world it no longer makes sense to think of people as born with fixed reserves of potential; instead, potential is an expandable vessel, shaped by the various things we do throughout our lives. Learning isn’t a way of reaching one’s potential but rather a way of developing it. We can create our own potential. - Peak: Secrets from the New Science of Expertise

It’s about creating and developing new skills, not uncovering hidden skills. There is no such thing as hidden talent. We have been taught that we should search for our inherent passion because that must be the one thing we will be good at. We now understand there are very few things genetically “set” from the beginning and almost all new skills can be created and developed. The important question is how to create those skills.

2.       Hard Work is not Enough

But sometimes these books leave the impression that heartfelt desire and hard work alone will lead to improved performance— “Just keep working at it, and you’ll get there”—and this is wrong. The right sort of practice carried out over a sufficient period of time leads to improvement. Nothing else. - Peak: Secrets from the New Science of Expertise

“Just Work Hard”. Those three words are misused more often than any other piece of advice. It’s appealing because it makes sense on the surface. Of course nothing meaningful develops with partial effort. Read the histories of great leaders or musicians and you will always find a hard-fought struggle. We are taught this from an early age from our parents or coaches. It’s a good attitude to cultivate.

But there’s a problem. The growth benefits of hard work stop after a certain amount of time. No matter how much hard work we put in, our ability stops improving. It’s a frustrating situation. Why is something that worked in the past all of a sudden not working?

It stops working because we no longer direct that hard work into routines that stretch and expand our skills. We just repeat what we know, without embracing new challenges. Our abilities no longer respond to traditional hard work. We need something else…

Why should the teaching techniques used to turn aspiring musicians into concert pianists have anything to do with the training that a dancer must go through to become a prima ballerina or the study that a chess player must undertake to become a grandmaster?

The answer is that the most effective and most powerful types of practice in any field work by harnessing the adaptability of the human body and brain to create, step by step, the ability to do things that were previously not possible. - Peak: Secrets from the New Science of Expertise

The underlying habits and principles behind world class performance apply equally to athletics, music, or entrepreneurship. While the day-to-day activities are different, the principles of training design and growth are constant across domains.

If you wish to develop a truly effective training method for anything—creating world-class gymnasts, for instance, or even something like teaching doctors to perform laparoscopic surgery—that method will need to take into account what works and what doesn’t in driving changes in the body and brain. - Peak: Secrets from the New Science of Expertise

We miss harnessing the power to optimize how our mind incorporates and masters new skills. We’ve been coasting along, using vague ideas like “working hard” without realizing it’s only half the equation. The other half, based on Ericcson’s research, is too often neglected.

3.       Showing Up is not Enough

We all follow pretty much the same pattern with any skill we learn, from baking a pie to writing a descriptive paragraph. We start off with a general idea of what we want to do, get some instruction from a teacher or a coach or a book or a website, practice until we reach an acceptable level, and then let it become automatic. And there’s nothing wrong with that. For much of what we do in life, it’s perfectly fine to reach a middling level of performance and just leave it like that. - Peak: Secrets from the New Science of Expertise

So far, so good. With the help of a coach and some instruction, we practice and make progress. As Ericsson stated, that works for most activities in life. We don’t have to be superb at everything. But what about the skills we do want to be superb at? Why do we struggle to progress beyond good enough?

But there is one very important thing to understand here: once you have reached this satisfactory skill level and automated your performance—your driving, your tennis playing, your baking of pies—you have stopped improving. - Peak: Secrets from the New Science of Expertise

Most of us reach an acceptable level without knowing it. We keep practicing and assume we are improving, yet our real-world performance never improves.

How do we overcome this? Testing and feedback. We need to continually test our skills to provide objective feedback on our current ability. Without testing, we are left to guess at our skill level. And guesses don’t work for elite performers.

Testing provides feedback, giving us the direction and data to redirect our routines and practice. Our practice habits must evolve and adapt. If we keep the same static practice routines, we never develop new ways to improve our weaknesses.

People often misunderstand this because they assume that the continued driving or tennis playing or pie baking is a form of practice and that if they keep doing it they are bound to get better at it, slowly perhaps, but better nonetheless. They assume that someone who has been driving for twenty years must be a better driver than someone who has been driving for five, that a doctor who has been practicing medicine for twenty years must be a better doctor than one who has been practicing for five, that a teacher who has been teaching for twenty years must be better than one who has been teaching for five.

But no. Research has shown that, generally speaking, once a person reaches that level of “acceptable” performance and automaticity, the additional years of “practice” don’t lead to improvement. If anything, the doctor or the teacher or the driver who’s been at it for twenty years is likely to be a bit worse than the one who’s been doing it for only five, and the reason is that these automated abilities gradually deteriorate in the absence of deliberate efforts to improve. - Peak: Secrets from the New Science of Expertise

The dirty secret of “experience” is that people with 20 or 30 years of experience are often no better than those with 10 or 15 years of experience. We may want to believe that more is better, but have we ever tested or validated that assumption? Probably not. Most likely, we have assumed we must be better because we need to justify the years of effort and time invested. It’s agonizing to think about spending 20 years doing something and not improving. But we have to face reality, not what’s comfortable, if we want to grow.

This brings back the importance of testing and feedback. We must have objective guidance on our ability. If we assume or guess, we are fooling ourselves into believing we are something that we are not. And that is the downfall of anyone striving to become exceptional at their skill.

4.       Engage in Purposeful Practice

Purposeful practice has several characteristics that set it apart from what we might call “naive practice,” which is essentially just doing something repeatedly, and expecting that the repetition alone will improve one’s performance.

Purposeful practice has well-defined, specific goals. Our hypothetical music student would have been much more successful with a practice goal something like this: “Play the piece all the way through at the proper speed without a mistake three times in a row.” Without such a goal, there was no way to judge whether the practice session had been a success. - Peak: Secrets from the New Science of Expertise

By using goals, you transform random action into deliberate processes. Goal-based practice can be tracked and measured, providing valuable feedback. By focusing on specific goal-driven processes, we build practical skills.

Purposeful practice is all about putting a bunch of baby steps together to reach a longer-term goal.

Purposeful practice is focused.

Purposeful practice involves feedback. You have to know whether you are doing something right and, if not, how you’re going wrong.

Purposeful practice requires getting out of one’s comfort zone.

- Peak: Secrets from the New Science of Expertise

These four ideas move your actions beyond showing up and instead direct your effort into long-term progress. Small steps, focus, feedback, and uncomfortability are necessary for growth.

5.       Get Comfortable with being Uncomfortable

This is a fundamental truth about any sort of practice: If you never push yourself beyond your comfort zone, you will never improve…Generally the solution is not “try harder” but rather “try differently.” It is a technique issue, in other words.

The best way to get past any barrier is to come at it from a different direction, which is one reason it is useful to work with a teacher or coach. Someone who is already familiar with the sorts of obstacles you’re likely to encounter can suggest ways to overcome them. - Peak: Secrets from the New Science of Expertise

Purposeful practice focuses on things we can’t do well. If we keep repeating the things we are good at, we never overcome the obstacles that hold us back. Confronting our weaknesses is painful. It requires honesty and humility about our shortcomings. Practicing our weak points isn’t fun. It’s much easier to practice the things we are good at, since it’s inherently enjoyable to succeed. But we don’t progress when repeating the things we are good at.

If you can’t find a coach to provide feedback, you must create your own feedback to leverage. If it’s a physical skill, a video recording provides an impartial, outside look at your performance. If it’s academic/knowledge based, testing delivers valuable feedback. You may be tempted to skip these ideas and just “trust” your instincts. Unfortunately, you will be stuck wondering why you don’t see the progression you expect.

6.       Separate Knowledge from Skills

When you look at how people are trained in the professional and business worlds, you find a tendency to focus on knowledge at the expense of skills. The main reasons are tradition and convenience: it is much easier to present knowledge to a large group of people than it is to set up conditions under which individuals can develop skills through practice. - Peak: Secrets from the New Science of Expertise

Always separate knowledge from skill. It’s easy to add knowledge and confuse that with skill improvement. When we think of learning, we assume knowledge accumulation is good. But knowledge accumulation that doesn’t transfer to applied skills doesn’t help us. We may feel confident in the moment but we are mistaking that confidence for progress. Think about this. Of all the books you have read in your lifetime, how many have delivered actionable improvement? Have you converted that knowledge into long-term, applied skill?

From the perspective of deliberate practice, the problem is obvious: attending lectures, minicourses, and the like offers little or no feedback and little or no chance to try something new, make mistakes, correct the mistakes, and gradually develop a new skill. It’s as if amateur tennis players tried to improve by reading articles in tennis magazines and watching the occasional YouTube video; they may believe they’re learning something, but it’s not going to help their tennis game much. Furthermore, in the online interactive approaches to continuing medical education, it is very difficult to mimic the sorts of complex situations that doctors and nurses encounter in their everyday clinical practice.

It is not just the medical profession that has traditionally emphasized knowledge over skills in its education. The situation is similar in many other professional schools, such as law schools and business schools. In general, professional schools focus on knowledge rather than skills because it is much easier to teach knowledge and then create tests for it. The general argument has been that the skills can be mastered relatively easily if the knowledge is there. One result is that when college students enter the work world, they often find that they need a lot of time to develop the skills they need to do their job. Another result is that many professions do no better a job than medicine—and in most cases, a worse job—of helping practitioners sharpen their skills. Again, the assumption is that simply accumulating more experience will lead to better performance. - Peak: Secrets from the New Science of Expertise

As an investing professional, I’ve struggled to convert information into skill improvement. I’ve found it’s easy and seductive to absorb information, but much more challenging to find evidence my investing skill has actually increased. That’s the challenge for all knowledge workers. How do you ensure your skills are improving?

7.       Create Daily Routines

The hallmark of purposeful or deliberate practice is that you try to do something you cannot do—that takes you out of your comfort zone—and that you practice it over and over again, focusing on exactly how you are doing it, where you are falling short, and how you can get better. Real life—our jobs, our schooling, our hobbies—seldom gives us the opportunity for this sort of focused repetition, so in order to improve, we must manufacture our own opportunities. - Peak: Secrets from the New Science of Expertise

Deliberate and focused effort doesn’t happen by itself. We all have busy lives with little free time. Without consciously directing our behavior towards building expertise, we will never create consistent time for improvement. The first step must be a conscious decision to allocate time to this process. You will have to give something up. No one said this will come without at cost.

A similar thing is true for those who maintain purposeful or deliberate practice over the long run. They have generally developed various habits that help them keep going. As a rule of thumb, I think that anyone who hopes to improve skill in a particular area should devote an hour or more each day to practice that can be done with full concentration. Maintaining the motivation that enables such a regimen has two parts: reasons to keep going and reasons to stop. When you quit something that you had initially wanted to do, it’s because the reasons to stop eventually came to outweigh the reasons to continue. Thus, to maintain your motivation you can either strengthen the reasons to keep going or weaken the reasons to quit. Successful motivation efforts generally include both. - Peak: Secrets from the New Science of Expertise

Habits, routines, and schedules provide a necessary structure to enable commitment and persistency of the task at hand. Relying on willpower, luck, or fate won’t last. By creating a consistent habit to practice one hour a day, at a regular time, we stop trying to fit it in our schedule but rather fit our schedule around the practice. Once our routine is locked in our schedule, there is no ambiguity or uncertainty of when it will be done.

One of the best bits of advice is to set things up so that you are constantly seeing concrete signs of improvement, even if it is not always major improvement. Break your long journey into a manageable series of goals and focus on them one at a time—perhaps even giving yourself a small reward each time you reach a goal.            -Peak: Secrets from the New Science of Expertise

Instead of trying to tackle a hundred things at once, practice the building blocks one at a time. Focus each practice day on one unique aspect of your skill. Do this over the course of a year and you have a solid foundation of practical skills. Avoid the urge to do too much at one time. We all want to overachieve, but trying to do too much causes burnout and unfocused effort. Trust the process and commit to improving one thing at a time.

8.       Take Charge of Your Success

We need to start now. For adults who are already in the work world, we need to develop better training techniques—based on the principles of deliberate practice and aimed at creating more effective mental representations—that not only will help them improve the skills they use in their current jobs but that will enable them to develop new skills for new jobs. And we need to get the message out: you can take charge of your own potential. But it is the coming generations who have the most to gain.

The most important gifts we can give our children are the confidence in their ability to remake themselves again and again and the tools with which to do that job. They will need to see firsthand—through their own experiences of developing abilities they thought were beyond them—that they control their abilities and are not held hostage by some antiquated idea of natural talent. - Peak: Secrets from the New Science of Expertise

Success results from conscious and deliberate effort to improve our skills. No one will do this for you. As the world becomes more competitive and meritocratic, it’s your responsibility to grow your skills and demonstrate expertise. The idea of genetics or innate talent limiting your potential isn’t the real constraint. We have 10x the potential if we learn and grow using the principles of exceptional performers.

Peak Takeaways:

1.       Your Abilities are not Fixed

2.       Hard Work is not Enough

3.       Showing Up is not Enough

4.       Engage in Purposeful Practice

5.       Get Comfortable with being Uncomfortable

6.       Separate Knowledge from Skills

7.       Create Daily Routines

8.       Take Charge of Your Success

4 Secrets to Improve Your Workday: How to Build Career Success

#1 Routine, Not Willpower, is the Key to a Successful Workday

It was as if the first few times a rat explored the maze, its brain had to work at full power to make sense of all the new information. But after a few days of running the same route, the rat didn’t need to scratch the walls or smell the air anymore, and so the brain activity associated with scratching and smelling ceased. It didn’t need to choose which direction to turn, and so decision-making centers of the brain went quiet. All it had to do was recall the quickest path to the chocolate. Within a week, even the brain structures related to memory had quieted. The rat had internalized how to sprint through the maze to such a degree that it hardly needed to think at all. The key to a successful workday is to replace manual effort with habits and routines. Habits allow us to process more work without using extra energy that drains us by mid-afternoon. The attitude of hard work is great, but hard work has a downside because it depletes our energy levels when focused on low-value activities. We can’t produce quality work. -The Power of Habit, Duhigg

In his book, Power of Habit, Charles Duhigg explains how to channel habits into powerful assets to improve our lives.

How can we use these lessons to improve our workday?

The key to a productive workday is to substitute much of our “conscious” hard work into subconscious or automated habits that are less taxing on our energy systems.

Habits, scientists say, emerge because the brain is constantly looking for ways to save effort. -The Power of Habit, Duhigg

What type of work should become an automatic routine? Any repetitive and predictable activity. Emails. Office organization. Regular reports. Mundane transactions. Anything that has low variability is a good candidate for a habit.

What should not become habit? Any task that has high unpredictability or complexity. Because of the inherent variation in these tasks, automation will often lead to incomplete action and the wrong outcome. For example, hiring is a complex process that takes significant deliberate thought. It should not be automatic given the consequences of a bad hire and the variation of prospective employees.

Conserving mental effort is tricky, because if our brains power down at the wrong moment, we might fail to notice something important, such as a predator hiding in the bushes or a speeding car as we pull onto the street. -The Power of Habit, Duhigg

As mentioned above, we can’t power down our brains in high impact situations. It’s up to us to separate our day into routine habits and deliberate action, and not mix the two.

#2 Take a Step Back Before Judging Other’s Behavior

How do you react when a colleague makes a mistake that seems indefensible? Do you assume the person is just plain stupid? Do you assume they don’t care? Do you blame their work ethic or attention to detail?

Executives determined that, in some ways, they had been thinking about willpower all wrong. Employees with willpower lapses, it turned out, had no difficulty doing their jobs most of the time. On the average day, a willpower-challenged worker was no different from anyone else. But sometimes, particularly when faced with unexpected stresses or uncertainties, those employees would snap and their self-control would evaporate. A customer might begin yelling, for instance, and a normally calm employee would lose her composure. An impatient crowd might overwhelm a barista, and suddenly he was on the edge of tears. -The Power of Habit, Duhigg

There is constant tension between the effects of our environment and our ability to influence and control those effects. When we see other’s behavior, we often attribute 100% of that behavior to the person and completely neglect the role of environment. Seldom do we let the person off the hook and blame the environment. It *seems* to make intuitive sense that we are in 100% in control of our actions. Numerous studies have rebuked that belief, but it still persists in managerial behavior.

When we make a mistake, we are likely to blame outside factors instead of looking inward at ourselves. And when something goes right, we often take all the credit and assume the environment had nothing to do with it. We accept all praise and deflect all blame. It’s hard to overcome.

But when dealing with colleagues, hold your initial impression since you likely underestimate the power of the situation.

#3 Use a Crisis to Shake Things Up

After Barack Obama’s election, Rahm Emanuel said, “You never want a serious crisis to go to waste.”

You may not agree with his politics, but he had a powerful point.

All those leaders seized the possibilities created by a crisis. During turmoil, organizational habits become malleable enough to both assign responsibility and create a more equitable balance of power. Crises are so valuable, in fact, that sometimes it’s worth stirring up a sense of looming catastrophe rather than letting it die down. -The Power of Habit, Duhigg

Although a crisis is not a pleasant thing, many organizations waste the opportunity to improve their habits by learning from the crisis. The initial reaction is often hysteria and an ultra-short-term focus on the immediacy of the crisis, rather than improving long-term behavior.

Employees often follow the cues of their leaders. If leaders can’t separate the crisis from the learning, why should they expect employees to do the same? It takes a certain stoic mindset to compartmentalize the urgent crisis from the long-term lessons.

One a crisis has occurred, it’s a sunk cost and no amount of ruminating and stressing will undue the past. The best we can do is learn to modify our routines to ensure the same crisis doesn’t happen again.

#4 Corporate and Employee Behavior is Shaped by Social Convention

Your behavior mimics those around you.

Have you considered your behavior is significantly influenced by those around you? Do you believe you are 100% in control of your actions and habits?

…firms are guided by long-held organizational habits, patterns that often emerge from thousands of employees’ independent decisions. And these habits have more profound impacts than anyone previously understood. -The Power of Habit, Duhigg

It’s likely you have less control than you think. Unless you deliberately engage and understand your habits, you are bound to repeat the same patterns and actions. Your day to day activities are a consequence of the cues and expectations of those around you.

Many behaviors are not a result of deliberate thought but rather an evolving collection of haphazard and unexamined beliefs.

For example, companies often want employees to engage in deep thinking on breakthrough or revolutionary projects. However, they also expect constant and immediate email responses. Studies have shown that by interrupting deliberate effort, it takes 20-40 minutes to re-engage in deep learning.

While the company is hoping for one thing (deep thinking) they are getting something else (distracted workers handicapped by email). The actions of the company must match the words spoken by management. When there is conflict, the actions always win. 

If you want to change behavior, don’t expect more information to alter deep-seated organization behavior. It’s not an information problem. It’s a habit and expectations problem.

A movement starts because of the social habits of friendship and the strong ties between close acquaintances. It grows because of the habits of a community, and the weak ties that hold neighborhoods and clans together. And it endures because a movement’s leaders give participants new habits that create a fresh sense of identity and a feeling of ownership. Usually, only when all three parts of this process are fulfilled can a movement become self-propelling and reach a critical mass. -The Power of Habit, Duhigg

Your focus should first start with company-wide behavior, then re-train organization behavior with systematic training, and finally reinforce with social proof.

A movement starts because of the social habits of friendship and the strong ties between close acquaintances. It grows because of the habits of a community, and the weak ties that hold neighborhoods and clans together. And it endures because a movement’s leaders give participants new habits that create a fresh sense of identity and a feeling of ownership. Usually, only when all three parts of this process are fulfilled can a movement become self-propelling and reach a critical mass. There are other recipes for successful social change and hundreds of details that differ between eras and struggles. -The Power of Habit, Duhigg

To Summarize:

#1 Routine, not willpower, is the key to a successful workday – Quit trying to force your way through bad habits. Re-train and eliminate them instead.

#2 Take a step back before judging other’s behavior – Before rushing to judgment, step back and reflect on situational factors that have shaped people’s behavior.

#3 Use a crisis to shake things up – Rise above the day-to-day challenges of a crisis and learn to modify behaviors instead of ruminating on past mistakes.

#4 Corporate and employee behavior is shaped by social convention – Employee behavior is often shaped by social factors, not rules and logic. If you want to change behavior, alter social expectations.

Book Notes: Average is Over by Tyler Cowen

Overall rating: 6/10

General Thoughts:

"Average is Over" for most Americans. Tyler Cowen, author of the book, Average is Over, makes the case that people/workers will increasingly be separated into a small, hyper-valuable upper class and a growing, stagnant lower working class.

I took Tyler’s concepts and applied them to the likely readers of this article. If you think you are immune to competition because of your fancy degree or high paying position, you are slowly starting your demise.

Competition is unrelenting and those who sit around waiting for things to happen will be run over by technological change and better competition. Americans will continue to divide into two classes. But it's not just the wealthy vs. the poor; it’s the self-educated individuals vs. the passive class of Americans who expect the government, corporations, or their families to support and ensure their well-being. The quicker you accept the idea that it is your responsibility to educate yourself, the more likely you will thrive in the future. 

Worth reading?

It’s an interesting and motivational read if you are new to the idea of the hyper-competitive labor market. Cowen makes a compelling case why it’s only going to get tougher for workers, not easier. If you need to get motivated, read the book.

If you already understand this, there isn’t much help you direct what you should be doing to compete. He leaves just vague notions of building new skills and leveraging technological and marketing skills for the future. It would be nice to have an actual roadmap of how to do that, but wasn’t necessarily part of his goal for this book.

This article explores 5 ways to rethink your career position and inspire you to go on the offensive by creating rare and valuable skillsets.

My Kindle Notes (some notes may be cut off/incomplete)

This imbalance in technological growth will have some surprising implications. For instance, workers more and more will come to be classified into two categories. The key questions will be: Are you good at working with intelligent machines or not? Are your skills a complement to the skills of the computer, or is the computer doing better without you? Worst of all, are you competing against the computer? Are computers helping people in China and India compete against you? 76

To put the question in the bluntest possible way, let’s say that machine intelligence helps us make a lot more things more cheaply, as indeed it is doing. Where will most of the benefits go? In accord with economic reasoning, they will go to that which is scarce. In today’s global economy here is what is scarce: 1. Quality land and natural resources 2. Intellectual property, or good ideas about what should be produced 3. Quality labor with unique skills 248

Here is what is not scarce these days: 1. Unskilled labor, as more countries join the global economy 2. Money in the bank or held in government securities, which you can think of as simple capital, not attached to any special ownership rights (we know there is a lot of it because it has been earning zero or negative real rates of return) 252

will be the humans who are adept at working with computers and with related devices for communications and information processing. If a laborer can augment the value of a major tech improvement by even a small bit, she will likely earn well. That means humans with strong math and analytic skills, humans who are comfortable working with computers because they understand their operation, and humans who intuitively grasp how computers can be used for marketing and for other non-techie tasks. 268

Does anyone envy the job prospects of a typical newly minted astronomy PhD? On the other hand, Mark Zuckerberg of Facebook fame was a psychology major, and insights from psychology helped him make Facebook into a more appealing and alluring site. The ability to mix technical knowledge with solving real-world problems is the key, not sheer number-crunching or programming for its own sake. Number-crunching skills will be turned over to the machines sooner or later. 276

Despite all the talk about STEM fields, I see marketing as the seminal sector for our future economy. 280

Nonetheless, masseuses increasingly market themselves on Google and the internet. These masseuses fit the basic model that favors people who can blend computer expertise with an understanding of how to communicate with other people. Again, it is about blending the cognitive strengths of humans and computers. 284

It sounds a little silly, but making high earners feel better in just about every part of their lives will be a major source of job growth in the future. At some point it is hard to sell more physical stuff to high earners, yet there is usually just a bit more room to make them feel better. Better about the world. Better about themselves. Better about what they have achieved. 293

The more that earnings rise at the upper end of the distribution, the more competition there will be for the attention of the high earners and thus the greater the importance of marketing. 297

But don’t just focus on those computers; it’s also about management. The CEOs and higher-level managers are paid handsomely to assemble and direct the individuals who work every day with mechanized intelligent analysis. If you have an unusual ability to spot, recruit, and direct those who work well with computers, even if you don’t work well with computers yourself, the contemporary world will make you rich. If we look at the increase in the share of income going to the top tenth of a percent from 1979 to 2005, executives, managers, supervisors, and financial professionals captured 70 percent of those gains. Another development is this: The better the world is at measuring value, the more demanding a lot of career paths will become. That is why I say “Welcome to the hyper-meritocracy” with a touch of irony. Firms and employers and monitors will be able to measure economic value with a sometimes oppressive precision. 321

In any case, the slacker twenty-two-year-old with a BA in English, even from a good school, no longer has such a clear path to an upper-middle-class lifestyle. At the same time, Facebook, Google, and Zynga are now so desperate for talent that they will buy out other companies, not for their products, but rather to keep their employees. It’s easier and cheaper to buy the companies than to try to replicate their recruiting or lure away their best employees. Often the purchased product lines are abandoned. A recent report laid out how these acquisitions work: “‘Engineers are worth half a million to one million,’ said Vaughan Smith, Facebook’s VP of corporate development, who has helped negotiate many of the 20 or so talent acquisitions made by Facebook in the last four years.” The technology blogs call this being “acqhired,” and this practice is being ramped up in what is otherwise a slow job market. It’s not slow for those who work with the intelligent machines. 337

Let’s draw up a simple list of some important characteristics in technologically advanced modern workplaces: 1. Exactness of execution becomes more important relative to an accumulated mass of brute force. 2. Consistent coordination over time is a significant advantage. 414

3. Morale is extremely important to motivate production and cooperation. 417

The days of a lone worker in the field pushing a hoe are over, at least as a way to feed families. Think of the public works projects of the 1930s, such as paving a road. A healthy worker always can add some brute force to the endeavor, for instance by carrying bricks from one place to another on the construction site. The workers don’t have to be brilliant—they require only a minimum of training—and while conscientiousness plays a role, the monitoring and enforcement problems are relatively straightforward, as the workers either carry the bricks or they do not. 421

You might think it’s only Google and a few elite firms moving in this direction—meet a certain grade or you are out—but the practice is spreading to many corners of the job market. For instance, it’s now common that a fire chief has to have a master’s degree. That may sound silly and perhaps you think a master’s degree has not very much to do with putting out fires. Still, often it is desired that a firefighter be trained in emergency medical services, anti-terrorism practices, and fire science (for instance, putting out industrial fires), and there is a demand for firemen who, as they move into leadership roles, can do public speaking, interact with the community, and write grant proposals. A master’s degree is no guarantee of skill in these areas, but suddenly the new requirements don’t sound so crazy anymore. 469

We have been seeing what is called “labor market polarization,” a concept that is most closely identified with MIT labor economist David Autor. Labor market polarization means that workers are, to an increasing degree, falling into two camps. They either do very well in labor markets or they don’t do well at all. It’s hardly the case that America has lost its middle class as of 2013, and I would urge you to stay away from some exaggerated accounts of the middle class having been “decimated,” but looking toward the future the trend is clear: The middle of the distribution is thinning out and this process appears to have a long ways to run. And to be blunt—while I know I can’t prove this—I wonder how much of the middle class consists of people in government or protected service-sector jobs who don’t actually produce nearly as much as their pay. 477

It’s clear: The world is demanding more in the way of credentials, more in the way of ability, and it is passing along most of the higher rewards to a relatively small cognitive elite. After all, the first two categories of earnings winners—namely those with advanced degrees—account for only about 3 percent of the US population. 511

As a general rule, the age structure of achievement is being ratcheted upward due to specialization and the growth of knowledge. Mathematicians used to prove theorems at age twenty, but now it happens at age thirty because there is so much more to learn along the way. If you are a talented twenty-two-year-old, just out of Harvard, you probably cannot walk into a furniture factory and quickly design a better machine. Young people have made fundamental contributions in some of the internet and social networking sectors, precisely because of the immaturity of those sectors. Mark Zuckerberg needed a good grasp of Myspace, but he didn’t have to master decades of previous efforts on online social networks. He was close to starting from scratch. In those cases, young people tend to dominate the sector, but of course that won’t cover the furniture factory. 526

It often sounds like meaningless or bogus clichés to outsiders, but very often the people in the field do not get it or do not think very conceptually about their own operations. It’s not in their training, and in the meantime they have become hyperspecialized in some very particular daily routines, such as mastering how a factory for producing furniture should be run. Every now and then these questions, rooted in general intelligence, pay off and generate a high expected return. The ever so popular management books, which can seem so banal to outside observers, are also attempting to supply critical outside general intelligence. It’s a hard set of conceptual skills to communicate and then turn into practice, and thus the demand for consultants—including young consultants—won’t be disappearing anytime soon. The flow of business and management books will probably never end. 548

But for men, from 1969 to 2009, as measured, it appears that wages for the typical or median male earner have fallen by about 28 percent. I’ve seen attempts to dispute these numbers, but the result remains embarrassing; Brookings Institution researcher Scott Winship, for instance, argues that since 1969 the truth is that male wages have fallen by “only” 9 percent. That’s still a dismal record. Imagine yourself as an economist back in 1969, being asked to predict the course of American male wages over the next forty years or so. You are told that no major asteroid will strike the earth and that there will be no nuclear war. The riots of the 1960s will die out rather than consuming our country in flames. Communism would go away as a major threat and most of the world would reject socialism. Who would have thought that wages for the typical guy were going to fall? It’s a stunning truth. 651

So what happens to laid-off workers, at least those who are still capable of working and willing to work? Whether we like it or not, many of them need to find lower-paying jobs. There are plenty of lower-paying jobs in the world, more than ever before, but here are the rather significant catches: 1. A lot of those jobs are being created overseas. If the job does not require high and complex capital investment, the advantage to keeping that job in the United States is lower. 2. A lot of Americans are not ready to take such jobs, either financially or psychologically. They have been conditioned to expect “jobs in the middle,” precisely the area that is falling away. 3. Through law and regulation, the United States is increasing the cost of hiring, whether it be mandated health benefits, risk of lawsuits, or higher minimum wages. 728

Among the young there is a growing tendency to postpone adulthood, in part because lucrative job opportunities do not beckon. The new crowd of youngsters is sometimes called “Generation Limbo.” They end up living at home for longer, they take freelance and part-time service work—such as in bars or bookstores—or they write part-time for websites. It is less likely that their first or even second jobs will count as potential “careers.” I do not presume the limbo generation consists entirely or even mostly of unhappy individuals. They have freedoms and flexibilities that older generations might have envied, and they have the chance to spend lots of time with friends and family. Sex and parties and good ethnic food seem to be everywhere, if Facebook is any kind of guide. Still, the longer-run job prospects for many of this crop of twentysomethings may not turn out to be so great. 773

Rajlich stresses that humans blunder constantly, that it is hard to be objective, hard to keep concentrating, and hard to calculate a large number of variations with exactness. He is not talking here about the club patzer but rather the top grandmasters: “I am surprised how far they are from perfection.” In earlier times these grandmasters had a kind of aura about them among the chess-viewing public, but in the days of the programs the top grandmasters now command less respect. 1229

At the cognitive level, this unexpected depth is also a disturbing result. It shows that we humans—even at the highest levels of intellect and competition—like to oversimplify matters. We boil things down to our “intuitions” too much. We like pat answers and we take too much care to avoid intellectual chaos. Even if you don’t think those flaws apply to everybody, they seem to apply to some of the most intelligent and analytic people in the human race, especially good chess players. 1291

What does all this mean for our decisions, especially in the workplace? 1. Human strengths and weaknesses are surprisingly regular and predictable. 2. Be skeptical of the elegant and intuitive theory. 3. It’s harder to get outside your own head than you think. 4. Revel in messiness. 5. We can learn. 1295

We see a bias toward regularized systems, rather than ideal systems, in the rise of the Kalashnikov AK-47, the world’s most popular gun. It is not the technologically most advanced weapon, nor the most powerful, but it is easy to shoot, reload, and also fix. Sadly, you can give one to a child and have a working weapon rather quickly (as happens all too often during civil wars around the globe). Microsoft Word, in similar fashion, has succeeded because of ease of use and interchangeability, not because highly informed experts think it is the best software possible. 1383

The Google crutch, if I may call it that, influences how we think and how we learn. There’s now good systematic evidence about how Google changes our mental capacities, and I think most of us have experienced this personally as well. When people use Google more, they lose some of their ability—or at least willingness—to remember facts. After all, why should you keep track of all that stuff? If it is a factual question, the answer probably is right at your fingertips, especially with smart phones and iPads. In similar fashion, it seems that people who manage accounts became less skilled at some memory functions once they obtained cheap paper, writing instruments, accounting books, and other means of keeping track of figures. 1809

The ancient arts of memory, in their most general form, are techniques to improve your mind. These arts were not just about memorization and many of their advocates drew an explicit distinction between the memory arts and memorization. The memory arts were about learning how to order ideas in new ways, and thus the memory arts were a path to composition and innovation and the generation of novelty. It was about taking older and simpler parts and from those parts making new things, be they hymns, poems, prayers, books, or a new appreciation of the wonders of God. 1819

Two different effects are operating here, but we can tease them apart for a look at where humanity is headed. On one hand, many successful individuals will learn how to think like smart machines, or at least enough to understand their operation, in order to become wealthy, high-status earners. In that way we will become more like computers—well, a large number of high earners will become more like computers anyway, cognitively speaking. That said, when it comes to our private lives, we will become less like computers, because we rely on computers for many basic functions, such as recording numbers, helping us with arithmetic, and remembering facts through internet search. In these ways we will become more intuitive, more attuned to the psychology and emotions of everyday life, and more spontaneously creative. 1848

Looking back, we have seen a great stagnation of wages in the United States since about 1973. Given that this book offers a view of how that era of stagnation is going to evolve into a new chapter in our nation’s history, it is worth addressing how much of the stagnant wage trend in the United States was or might remain due to foreign competition. 1901

Should we blame the foreigners for our difficulties? And how will foreign competition shape jobs and wages going forward? Many economists are skeptical of arguments that lay the blame for our weak job market on foreign trade. The notion that foreign competition causes low wages and unemployment has been around for centuries. Yet foreign competition continues to grow, and for the most part, at least until recently, wages have continued to rise. Furthermore, there are plenty of highly open, high-trade economies with employment success stories, most notably Switzerland, which at the end of 2011 had an unemployment rate of only 3.1 percent. Sweden’s story is broadly similar. 1903

Economists have been investigating the claim that foreign competition destroys jobs for a long time. It remains difficult to substantiate that claim. It is easy to throw around charges that American workers now have to compete with billions of new workers, many from formerly Communist or Socialist countries, yet most of those billions are not serious competitors, most of all because they have very low productivity. 1908

The most detailed study of labor’s falling share in output finds that new information and communications technologies—which can substitute for labor—play a larger role in compensation shifts than does foreign trade. 1913

It’s also hard to find serious evidence that immigration has hurt American wages in a significant way. Harvard professor George Borjas, a leading critic of our current immigration policies, has presented evidence that immigrants have lowered the wages of high school dropouts, in the long run, by 4.8 percent. But the wages of many other Americans have risen, and some major groups, such as the college educated, have suffered a long-run loss of 0.5 percent in wages, which is close to no effect at all. And that’s what the major immigration critic finds. 1915

What about exporting work to workers outside the United States? Some of my economist friends will hate this: It is increasingly hard to deny that outsourcing is playing some role in stagnant American wages and slow job creation. 1926

It’s simple. Hiring someone is an investment. If some jobs are becoming “higher investment value” while others are becoming “lower investment value,” entrepreneurs and their companies will put the lower investment value jobs in cheaper, lower-wage countries. Some of those jobs will stay in the United States, but only by paying lower wages than would otherwise be the case. 1927

During these periods of prosperity we were world leaders in education—K–12 and university. There was a closer match between the skills required of workers at higher levels of the value chain and the skills that American workers actually possessed. Nowadays, the demands of machinery—including of course computers—are rising at a faster rate than are human capabilities. The machines are getting better education, more rapidly and more cheaply, than are their human teammates and potential teammates. That’s the root of the problem for a lot of workers. 1987

What we see happening is that individuals with college degrees are gravitating to areas where a relatively high percentage of the other individuals also have college degrees. Some of the winning areas are Raleigh, North Carolina, San Francisco, and Stamford, Connecticut, where over 40 percent of the adult residents have college degrees. You can add select areas of New York, Chicago, and Los Angeles to this list, although those cities as a whole do not show uniform progress in recruiting educated individuals. Some of the loser cities include Bakersfield, California, and Youngstown, Ohio, where the percentage of educated adults is less than one-fifth. It should come as no surprise that the cities with high levels of education tend to have much lower levels of unemployment. We see also that in terms of per capita income, the poorer regions of the United States are no longer catching up to the wealthier regions. 2035

It is worth considering a little more exactly the new ways in which distance does and does not matter. Because of the internet and Amazon, among other developments, it is easier to become self-educated in many more different parts of the world. It is also easier to have a “good enough” or low budget (but happy) life in many more different parts of the world, again because of technology. But if you wish to be a high earner, learning from other well-educated people, geographic proximity is growing in importance, whether in companies or in leading amenities-rich cities or most likely in both. 2050

We as a nation have been thinking about education without knowing what we really want from it. Do we want well-rounded young adults to emerge? Or good citizens? Role models? These goals seem reasonable but what do they mean? For the purposes of this chapter, and indeed this book, I’ll keep the goal simple. One goal of better education is to procure better earnings. How we might achieve that is the question. 2112

Online education is one place where the new information technologies are emerging. For instance, millions of people are taking MOOCs (massive open online courses) or using the free instructional videos from Khan Academy on mathematics and other topics. Circa 2013, no one is surprised when a new foreign aid program consists simply of dropping iPads into rural Ethiopia and letting children figure out how to work them. 2124

Online education is expanding beyond its niche status, but sometimes we don’t recognize the most important developments as explicit education. In my own field of economics, what is the most common and regular form of contact the general public has with economic reasoning? It’s no longer the Econ 101 class but rather it is economics blogs, which are read by hundreds of thousands of people every day. I submit that “cross-blog dialogue,” as I call it, is for many people a better way of learning than boring lectures, PowerPoints, and dry, overly homogenized, designed-not-to-offend-anybody textbooks. Schools are supposed to be proper and politically correct, but sometimes the point really sticks when Paul Krugman calls someone an idiot on his popular blog and explains why—whether or not you agree with Krugman or the (supposed) idiot. Blogs have to get people to care because it is a very competitive environment. The competition is to capture anyone’s attention. 2127

It’s not just formal online education and blogs. Apps, TED lectures on YouTube, Twitter, reading Wikipedia, or just learning how to work and set up your iPad are all manifestations of this new world of competitive education, based on interaction with machine intelligence. These new methods of learning are all based on the principles of time-shifting (watch and listen when you want), user control, direct feedback, the construction of online communities, and the packaging of information into much smaller bits than the traditional lecture or textbook chapter. 2133

Online education is even growing as a supplement to K–12 or in some cases as a replacement altogether. As of late 2011, about 250,000 K–12 students are enrolled in full-time virtual schools. Over two million K–12 students take at least one class online. At these online schools, the degree of contact with flesh-and-blood teachers varies. Instructors might answer questions by email, phone, or videoconference, supplemented by periodic meetings, class trips, and “live,” in-the-classroom exams. It’s often for less than half the price of a traditional K–12 schooling experience. 2139

The first is that online education will be extremely cheap. Once an online course is created, additional students can be handled at relatively low cost, often close to zero cost. (We can even look forward to the day where essay questions are graded by artificial intelligence, and indeed some examples of this already are succeeding.) Over time, competitive pressures will operate to push price down close to costs. That’s not quite the world we have today, because setup costs for the classes remain a burden and most good colleges and universities have radically incomplete online offerings. It is also true that getting official accreditation for these courses is far from easy. 2151

Fourth, online education also allows for a much more precise measurement of learning. Consider the Khan Academy and its online videos. They are already measuring which videos lead to the best performance on quiz scores, which videos have to be watched more than once, at which point in the videos individuals stop for pause and replay, and so on. We are creating a treasure trove of information about actual learning, and we are just beginning to mine this data. 2183

If a student is falling behind, or in denial about his or her progress in the course, the software is the first to know. We’re about to apply “Big Data” to the students themselves, and man and machine will work together to improve significantly the quality of education. In a slightly more distant future, we can imagine the computers hooked up to bodily sensors of pulse and scans of facial movements, perhaps to determine if the student is bored, distracted, or simply not understanding the material. 2186

For all the successes of games, however, they also point out some limitations of education by computer, at least how we currently practice it. Education into the world of games works remarkably well, but it works mainly for people who wish to learn the games. Chess-playing computers don’t boost the play of diffident students who refuse to spend much time with the machine. For people who aren’t already motivated, or on the verge of picking up a new fascination, nothing about the game is all that enticing or seductive. 2214

Sometimes a student may care about doing well with grades but not about mastering the actual material and moving on to the next step. Chess teacher Peter Snow reports that some of his young students love playing against the computer, but they deliberately put the quality settings on the program so low that they can beat it many times in a row. At this point they should raise the skill level of the program to make the challenge tougher, but they don’t always want to do so. Similarly, studies of spelling bees show that the winning spellers are those who not only work hard, but who engage in disciplined forms of study that do not always yield immediate positive feedback. 2217

The superstars will reach higher and more dramatic peaks, and at earlier ages. Magnus Carlsen is, as I write, the highest rated player in the world and arguably the most impressive chess prodigy of all time, having attained grandmaster status at thirteen and world number one status at age nineteen, the latter a record. He is from Tønsberg, in southern Norway, and prior to the computer age Norway has no record of producing top chess players at all. Even Oslo (Carlsen now lives on its outskirts) is a relatively small metropolitan area of fewer than 1.5 million people. Carlsen, of course, had the chance to play chess over the internet. 2233

Again, we see some analogous results popping up in online education. When Sebastian Thrun, then of Stanford, taught his artificial intelligence course online, the best performers were not the students from Stanford. Generally the best performers were the students abroad, often from poor countries and very often from India. All of a sudden these individuals had a chance to outperform the US domestic elites. It is no surprise that recent speculation has centered on whether tech employers and other companies might use online courses as a new way to recruit talent. 2244

Online education can thus be extremely egalitarian, but it is egalitarian in a funny way. It can catapult the smart, motivated, but nonelite individuals over the members of elite communities. It does not, however, push the uninterested student to the head of the pack. Here is yet another way in which the idea of a hyper-meritocracy will apply to our future. 2248

It remains to be seen whether online education will spread with equal rapidity but most likely it will not. One major problem is simply that universities are for the most part bureaucracies. Faculty often fear online education because they sense it will either put them out of a job, lower their status and importance, or force them to learn fundamentally new methods of teaching, none of which sound like pleasant prospects, especially for a class of individuals used to holding protected jobs that involve a certain amount of autonomy and indeed coddling. 2259

It will become increasingly apparent how much of current education is driven by human weakness, namely the inability of most students to simply sit down and try to learn something on their own. It’s a common claim that you can’t replace professors with Nobel-quality YouTube lectures because the professor, and perhaps also the classroom setting, is required to motivate most of the students. Fair enough, but let’s take this seriously. The professor is then a motivator first and foremost. Let’s hire good motivators. Let’s teach our professors how to motivate. Let’s judge them on that basis. Let’s treat professors more like athletics coaches, personal therapists, and preachers, because that is what they will evolve to be. 2337

As it currently stands, we are losing track of a college education’s real comparative advantage. This was an acceptable bargain when the wages of educators and administrators were low, and government budgets had more slack, but it’s becoming increasingly expensive. 2348

We like to pretend our instructors teach as well as chess computers, but too often they don’t come close to that ideal. They are something far less noble, something that we are afraid to call by its real name, something quite ordinary: They are a mix of exemplars and nags and missionaries, packaged with a marketing model that stresses their nobility and a financial model that pays them pretty well and surrounds them with administrators. It’s no wonder that this very human enterprise doesn’t always work so well. 2350

What does the resulting model of education look like? The better-performing students will be treated much as chess prodigies are today. They will be given computer programs to play with, with periodic human contact for guidance, feedback, and upgrades to new and better programs. They will cooperate with each other toward the end of greater mastery of their subject areas. Their conscientiousness, and the understanding that high wages await them in the world, will enforce hard work and discipline. 2357

The lesser-performing students will specialize in receiving motivation. Education, for them, will become more like the Marines, full of discipline and team spirit. Not everyone will adopt the so-called “tiger mother” or Asian parenting style, but its benefits will become more obvious. A lot of softer parents will hire schools and tutors to do this for them. The strict English boarding school style of the nineteenth century will, in some form or another, make a comeback. If your eleven-year-old is not getting with the program, you will consider sending him away to the hardworking, whip-cracking Boot Camp for Future Actuaries. 2361

When a person is not doing what he or she is supposed to be doing, someone has to deliver that message in just the right way. Show up on time! Don’t shop online at your desk! Sell more of our products! Listen more closely to our customers! It is a complicated communication because you are both making the person feel bad about what they have been doing and getting them willing to achieve better results. Expert coaching or motivating will be a competitive growth sector for jobs. 2396

And just as conscientiousness will become a more important quality in labor markets, so will teaching and instilling conscientiousness become more important in the economy as a whole, a theme outlined by Daniel Akst in his brilliant yet neglected 2011 book We Have Met the Enemy: Self-Control in an Age of Excess. A lot of new jobs will be coming in the area of motivation. These jobs will require some very serious skills, but again they won’t primarily be skills of a high tech nature or skills that are taught very well by our current colleges and universities. And again, these high expertise coaching jobs won’t be shipped overseas. 2399

High-skilled performers, including business executives, will have some kind of coach. There will be too much value at stake to let high performers operate without a steady stream of external advice, even if that advice has to be applied rather subtly. Top doctors will have a coach, just as today’s top tennis players (and some of the mediocre ones) all have coaches. Today the coach of a CEO is very often the spouse, the personal assistant, or even a subordinate, or sometimes a member of the board of directors. Coaching is already remarkably important in our economy, and the high productivity of top earners will cause it to become essential. 2403

At various career steps, individuals who work with genius machines will need to retrain and learn new systems. Some will opt for self-education, supplemented by programs and some human guidance, much like the chess prodigies. Those who are less self-motivated will subject themselves to extreme forms of discipline for short periods of time, to learn a new set of skills. And others will retreat into the world of what I have called threshold earners, just trying to get by. 2409

Larry Kaufman, who developed the evaluation function for the Rybka program, and who is the mastermind of the Komodo program, graduated from MIT with an undergraduate degree in economics in 1968. He went to work on Wall Street as a broker and soon started developing his own form of options-pricing theory, working independently of Fischer Black and Myron Scholes; Scholes later won a Nobel Prize for that contribution. Kaufman’s theory was based on ideas of Brownian motion and the logistic function, the latter of which he took from formulas for calculating chess ratings. In the 1970s he made money by applying his options-pricing work through a trading firm and stopped when the profits went away, and he has since dedicated his life to chess and computer chess, including his work on Rybka and Komodo. He lives in a fine house in one of the nicest parts of suburban Maryland, with his beautiful wife and young daughter. Again, we see the mix of a moderate level of elite education combined with extreme self-education over many years. 2416

In his midsixties, Kaufman is still making pioneering contributions to the theory and practice of intelligent machines. He and Nelson Hernandez are good examples of the kind of skills that will win out in the future. Above all else, they are masters of reeducation. 2423

Science is a general framework for making predictions, controlling our environment, and understanding our world. 2430

We should not, however, take that state of knowledge as fixed. I’m not talking about a decline in literacy here—science itself is, in many areas, moving beyond the frontiers of ready intelligibility. For at least three reasons, a lot of science will become harder to understand: 2438

1. In some (not all) scientific areas, problems are becoming more complex and unsusceptible to simple, intuitive, big breakthroughs. 2. The individual scientific contribution is becoming more specialized, a trend that has been running for centuries and is unlikely to stop. 3. One day soon, intelligent machines will become formidable researchers in their own right. 2440

Specialization As science progresses, each new marginal discovery is more the result of specialization and less the result of general breakthroughs, compared to earlier times. There probably won’t be another Isaac Newton, Adam Smith, or Euclid, because the most fundamental contributions in those fields have already been made. 2445

The major inventions behind the Industrial Revolution, for instance, were often driven by amateurs. That’s become a lot harder because there is so much knowledge to master in the mature fields. It can take ten years of study or more to get to the frontier of a lot of areas, and by the time you get there, and figure out something new, your contribution is a marginal one or maybe a little out-of-date. The frontier moved on while you were trying to master it. 2470

Even if you succeed, you’ll understand why your tweak is better than the way things used to be done, but your understanding of the new device as a whole may be rudimentary or even incorrect, because you relied so much upon the underlying knowledge of others. 2473

For more general writings on conscientiousness, see Brent W. Roberts, Carl Lejuez, Robert F. Krueger, Jessica M. Richards, and Patrick L. Hill, “What Is Conscientiousness and How Can It Be Assessed?”, Developmental Psychology, 3171

also Angela L. Duckworth, David Weir, Eli Tsukayama, and David Kwok, “Who Does Well in Life? Conscientious Adults Excel in Both Objective and Subjective Success,” Frontiers in Personality Science and Individual Differences, online first publication, September 28, 2012. 3173

On fire chiefs and master’s degrees, see Paul Fain, “Advanced Degrees for Fire Chiefs,” Inside Higher Ed, October 27, 2011, http://www.insidehighered.com/news/2011/10/27 /college-degrees-increasingly-help-firefighters-get-ahead#ixzz1f0qkakYi. On rising degree requirements more generally, see Catherine Rampell, “Degree Inflation? Jobs that Newly Require B.A.’s,” The New York Times Economix blog, December 4, 2012. 3185

For a general look at the cognitive abilities of chess players, see Fernand Gobet and Neil Charness, “Expertise in Chess,” in The Cambridge Handbook of Expertise and Expert Performance, edited by K. Anders Ericsson, Neil Charness, Paul J. Feltovich, and Robert R. Hoffman (New York: Cambridge University Press, 2006): 523–38. 3297

On spelling bees, see Angela Lee Duckworth, Teri A. Kirby, Eli Tsukayama, Heather Berstein, and K. Anders Ericsson, “Deliberate Practice Spells Success: Why Grittier Competitors Triumph at the National Spelling Bee,” Social Psychological and Personality Science, published online October 4, 2010, doi: 10.1177/1948550610385872. 3407

Why Possession of Knowledge Does Not Equal Expertise How it Blocks Our Personal Growth

 “Mere possession of knowledge is not enough for expertise. It is also critical for knowledge to be organized so that it can be activated and used in different contexts. Others emphasize flexible application of knowledge in new situations…Research on human performance shows that calling to mind knowledge is a significant cognitive process.”

– From Perspectives on Human Error: Hindsight Biases and Local Rationality, Woods and Cook

A collection of facts is not enough.

As Charlie Munger stated, “You can’t just memorize and bang out facts – they need to be in a latticework of mental models.”

This is the opposite approach of how you studied in undergrad or high school. You probably crammed your way through school. Unfortunately, cramming doesn’t work long-term.

What’s the alternative to cramming random facts in your head? Building a latticework structure in your mind to organize information in a logical and coherent system.

When you encounter certain problems, you must correctly interpret the situation and trigger the right information from your memory. This process will select the right model or framework to solve the problem. It’s like a flowchart. You follow the path based on your observation and interpretation of the problem. Because your training has created applicable models of real-world concepts, you simply follow the logical path to the correct solution.

It is not, and cannot be, a random collection of facts. The reason why is due to framing.

Framing is an important concept. Experts understand how the same problem will occur in different frames. Frames are simply different ways of presenting the same problem by changing the environment or situational context. As they progress through training, experts are aware that overconfidence can set in because they predict where standard questions are heading. However, the future will throw curveballs and almost imperceptible changes if experts don’t understand the problem’s frame. Misunderstanding the frame leads them to recall the wrong set of facts.

When we confuse knowledge with expertise, we lack the ability to recall knowledge and apply it to novel and unique situations. These situations have the same underlying problem yet occur in a different environment. If we are overly focused on memorizing specific facts without understanding the principles, we only build knowledge that is useful in one frame or dimension. We need to turn information gathering into applied wisdom.

Wisdom is Applied Knowledge

You are not a hard drive – seek wisdom instead of facts.

It’s important to emphasize two things.

First, we have the tendency to overvalue low-value, quantifiable facts over systems or principal-based learning. We want to crank out facts immediately rather than learn adaptable long-term principles.

You achieve this by focusing on the quality of your preparation, not the quantity. Don’t become obsessed with adding quick facts. Focus on the how the facts align into principles. Quantity will come naturally, but it will not be valuable if the knowledge foundation is a collection of random ideas. Once quality is firmly established, add quantity. Then, each additional knowledge block is reinforcing the connections in your brain, because you took the time to create a system to organize and apply new ideas.

Second, your brain is not a hard drive. You don’t get smarter by packing in more random facts about the world. This really only works for your short-term memory. In fact, most of us, including myself, packed our short-term memory during college as we studied for exams. We did this because we could and we didn’t know any better. We could get away with it. We got the grade we wanted, but left most of the long-term wisdom behind us.

This won’t work if you are striving to build exceptional skills and it’s a crappy way to go through life. There is a much better way to create long-term wisdom– and this idea gives you the framework to supercharge your time and effort, by consciously focusing and meticulously reorienting towards principal-based learning, not data gathering.

Wisdom is not the same thing as information. Wisdom is information + experience + context, and only a human can do that. Wisdom is information you can actually use. Here’s a better example of the difference between information and wisdom, an example Richard Feynman liked to use: The “name” of a thing is not the thing. Feynman’s dad taught him the name of a bird they saw (brown-throated thrush) in every language he knew. That’s just information. The wisdom came when he pointed out that you could know every name of that bird in every language but still know nothing about the bird itself. -Tucker Max

Dangerous Protest Threatens Harvard's Endowment

Just when the pressures on university endowments seem to abate, another misguided attempt to use endowments as a political weapon falls on Harvard. According to The Harvard Crimson and an article by Bloomberg’s John Lauerman, Hollywood stars, current students, and other activists are demanding Harvard’s endowment divest its holdings of fossil fuel investments. Protesters assert divesting will cut the use of fossil fuels and increase the use of alternative energy. How that would actually work is where the logic gets fuzzy. It’s a shame such a highly regarded institution can produce graduates who support such a misguided stunt. The protest lacks any coherent reasoning, threatens the objectivity of the endowment's staff, and paralyzes the investment decision making necessary for long-term success. Divestments are endemic of a trend to use headline-grabbing exploits instead of engaging in real constructive change.

No real effects...

Divestment of energy related investments have no negative effects on the companies. Managements are not going to change their corporate strategy and mission. Energy companies have dealt with critics for decades! Divesting simply sells the stakes to some other buyer. In the end, there is no real change in any of these transactions. The companies don’t lose any funding! Buyers and sellers trade all day without the company caring. It’s simply a smokescreen to persuade the unsuspecting Harvard community that something is being done. If protestors want to change something, how about producing some real innovation in the energy space that can help shift away from fossil fuels? Divestment tactics are a distracting and meaningless attempt to convince the public that change is occurring.

Invert, always invert...

In fact, protestors actually have it backwards! If they want to induce change, they should advocate increasing the stakes in fossil fuel companies! Higher ownership stakes enables shareholders to voice their opinions through proxy voting in favor of better environmental policies. It allows shareholders to confront company management and engage in real, substantive dialogue. Divestment accomplishes the opposite. It removes any chance to enable change by passing that responsibility onto someone else. Of course, I doubt protesters actually want to put that much work into this; it’s much easier to organize a sit-in!

Dangerous precedent...

Endowments are already under tremendous pressure from university leadership, faculty, and students to deliver above average investment returns to fund the facilities, professors, and students that make Harvard so great. What endowments don’t need are another set of backhanded and dubious mandates that distract investment staff from their real jobs. Harvard’s investment staff has one goal: to ensure the continued growth of the endowment, not to become a pawn in a political and environmental campaign.

As a former portfolio manager at a pension fund, I can felt the challenges of navigating the financial markets before dealing with interference by outside protesters. Pet projects like divestments undermine the investment process that Harvard has successfully built over the previous decades. Investment staff now have to consider if investments made today will someday be examined under a microscope, leading to second guessing the real mission of the endowment. The real victim in this divestment push is not the actual companies; it’s the students and alumni of Harvard who will realize fewer benefits and be asked to shoulder a higher burden for the university.

If protesters want curb the use of fossil fuels, they should start supporting alternative energy projects or fund their own energy startup. Unfortunately, they might find that real change requires hard work and deep commitment, not occupying a university building.

3 Ideas to Implement Today from Buffet's Annual Letter

Warren Buffet’s annual letters are usually packed with interesting insights, but for the past couple years I had been a little underwhelmed by his thoughts. This year’s letter was the exception. As I read the letter for the second time, I realized Buffet laid out exactly how an investor should construct an investment portfolio and evaluate businesses. Although investors won’t find actual recommendations, he delivers something more valuable: a framework for selecting and analyzing businesses that any serious investor can follow. If these lessons make sense to you, you will want to read the entire letter here.

It’s ironic that the lessons seem logical and obvious as he describes them, yet 90% of investors (both individual and institutional) will completely fail at following half of his advice. We can attribute that to attention spans of zero and the general get rich quick mentality. If investors can avoid those handicaps, this year’s letter was a real goldmine for investors who are looking for a sensible way to think about investing.

Although he gives his secrets away for free every year, implementation is always the hard part! I picked out a few of the best and most practical insights that you, the investor, need to follow. By shamelessly stealing Warren’s investment principles, you will be 95% of the way to an effective investment portfolio. Now, the lessons…

One: Businesses > Treasuries

Warren wasted no time describing the tremendous outperformance of U.S. businesses over US dollar denominated bonds over the past half century. As most investors flock to “safe” U.S. treasuries, Warren’s extols the impressive track record of owning American businesses over long time periods. The common perception that stocks are risky and bonds safe is completely discredited by the long term data. Of course, this is no absolute guarantee this will repeat in the future. But consider what you would rather own for the next 30 years: a sensibly priced business that can compound value at 10-15% per year or a 30 year treasury delivering 2.7%?

Investing should be thought of as buying businesses, not trading stocks. Buffet has slowly and methodically built his portfolio of great businesses without the manic-depressive emotions that occupy most investors. Your portfolio should be structured the same way. If you have the time and aptitude to evaluate businesses, wait until they go on sale, and then start building your portfolio.

Two: What Matters Most: Durable, Competitive Advantages

Buffet highlights one the best but most forgotten elements of investing. Warren and Charlie own businesses with durable competitive advantages that can compound value over time without needing excessive capital investment. Notice how he didn’t mention fast growth, growing market share, exciting technology, or world-changing products. He distills a great business into one line.

But how quickly do most investors forget what really matters! 99% of investing conversations revolve around superficial topics that are heavy in excitement but rarely touch on the elements of investment success. Do your investments satisfy this simple test? This idea is powerful because 1) it's free and 2) most investors won’t use it! Resist the urge to fool yourself into thinking you can ignore this advice and “beat the market”. Your portfolio will thank you.

Three: Price Matters

Although Buffet expounds on the promise of great businesses, he doesn’t pay any price for them. Even Buffet admits that at close to 2x book value, Berkshire may likely see price declines in the near future. How refreshing to have a CEO give an honest assessment of the stock price! Not many CEO’s admit their companies are priced to perfection; in fact today most CEO’s are paying egregious prices for their own stock!

Great businesses still need to be bought at sensible prices! What is sensible is debatable, but if your business evaluation skills are sufficient it’s generally achievable to be roughly right on the price. Great businesses are not on sale very often, but it certainly happens. The key is buying with deployable cash to pounce on opportunities (The 2008-2010 timeframe being the last great opportunity).

Price is an area where most investors screw up. We are hardwired to buy high and sell low, and even the best businesses make poor investments when bought at the wrong times. Activity will be skewed toward inaction 90% of the time, but the other 10% will provide incredible opportunities to pick up wonderful businesses at bargain prices.

Bonus: Charlie Munger’s Thoughts

Followers of Berkshire know the wisdom of Charlie Munger. Charlie didn’t disappoint as he gave us a few pages of insight in this year’s letter. I’ll leave you with one piece of advice that applies to both investing and life. Here Charlie describes one of the many aspects of how Warren set up his system for Berkshire Hathaway:

“His first priority would be reservation of much time for quiet reading and thinking, particularly that which might advance his determined learning, no matter how old he became…”

What great advice for investors and people in general! Notice he didn’t mention checking stock prices, scheduling meetings, or email. Great investors and great ideas are not built from at frantic pace at which the market operates. The compounding of knowledge over time will pay some large dividends if you don’t interrupt the process!

There is a treasure trove of great advice from Warren and Charlie on the Internet. Let me know and I can directly point you to the best material out there.

How a Famed Mathematician Can Make You a Better Investor

In the pursuit of building an investment education, I have found most insightful investment principles are often discovered in other disciplines. Investment books can be great, but most just rehash the same superficial material. True investment insight flows from deep principles that originated from other academic and professional fields.

Richard Hamming was a world renowned mathematician who pioneered research in computing and physics. He worked at the famed Bell Labs, helped design atomic bombs at Los Alamos, and advocated the redesign of mathematics education. Not only were his ideas valuable in computer science and physics, they clearly crossover into the investment world.

So what insights can Hamming share with investors that will enable a successful investment strategy?

Two foundational articles provide great insights for both beginning and sophisticated investors: “You and Your Research” and “A Stroke of Genius in Striving for Greatness in All You Do”. These articles provide a solid blueprint for constructing an investment education. Here are four ideas that readers can implement today.

“Great scientists have independent thoughts…and have the courage to pursue them.”

Hamming talked about the courage young scientists had to pursue new thoughts, instead of sticking with traditional methods. Great investors follow the same path. Independent thought is the linchpin for successful investing. Unaware to most investors, the outside influences we subconsciously entertain degrade the rational and logical mind necessary for investment success.

Great investing ideas often involve courage. The best opportunities are likely out of favor and take significant diligence to understand. Independence provides the clarity to see ideas in an unbiased light.

Investors are constantly being told what to buy, what to sell, and what to worry about. Sophisticated investors are extremely selective in what ideas and opinions they let through their filter. Investing doesn’t have to be a solo act, but each investor needs to build their own foundation.

Solution: My preferred method is to learn from other experts who have exhibited independence throughout their careers. Borrow ideas to fit your situation and mindset, rather than reinventing everything yourself. Some of my favorite examples are Richard Feynman, Teddy Roosevelt, and John Boyd.

“Knowledge and productivity are like compound interest. The more you know, the more you learn; the more you learn, the more you can do; the more you can do, the more the opportunity - it is very much like compound interest…One person who manages day in and day out to get in one more hour of thinking will be tremendously more productive over a lifetime.”

Investing requires diligent and consistent effort to build the competence to judge ideas and have the courage to stick with investments when times get tough. Investors have a nasty habit of interrupting compound growth to pursue hot ideas with a catchy story. Investor’s self-sabotage causes more problems than any geopolitical crisis or recession ever will.

Solution: Leverage great investors. My top 3 are Howard Marks, Warren Buffett, and James Montier. Build off their successes by reading one of their letters daily. Consistent effort in just a short time will yield tremendous results.

“You have to neglect things if you intend to get what you want done. There is no question about this.”

Not only is this quote practical for everyday life, it is also necessary for investors. There is too much information and distractions that bombard investors. To gain the necessary investment expertise and analytical edge, all superficial noise and wasted activity must be filtered away from investor’s attention. Whether it’s endless market commentary or concerns coming out of Europe, most of what investors read and hear has no useful purpose.

Solution: Make a conscious choice to go on an information/activity diet. Free up time that can be committed to building a particular investment skill. Abandon the thought of trying to conquer everything at once. Read a 10-K/Annual Report in your favorite industry each day and watch how a singular focus can deliver rapid investment growth.

“The people who do great work with less ability but who are committed to it, get more done that those who have great skill and dabble in it, who work during the day and go home and do other things and come back and work the next day. They don’t have the deep commitment that is apparently necessary for really first class work.”

Hamming’s insight is a great reminder to investors that investing is long term commitment. Just as great authors commit to their craft, great investors need to apply consistent effort in building their mental toolkit.

Solution: Decide how passionate and committed you are to improving your investment ability. The real test will occur when boredom & repetition sets in and you face a choice: keep building your skill or give up and see your progress unwind.