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.