Here’s to the Crazy Ones

It is Friday afternoon, around 4:30 pm, and Dan just got back to his desk from a meeting. He sees Janet, his manager’s boss, drinking coffee nearby. Dan’s son goes to the same school as Janet’s daughter and he has chatted with her before. Does Dan take this opportunity to talk to Janet or will he write some code for his project which is already late and might not be complete by its due date next week? The end of the quarter is coming up soon and about ten percent of his compensation is based on a bonus…

Disruption. This single word is among the most overused in the lexicon of business, especially in fields that are related to technology. It seems like every company under the sun hoping for venture capital funding has a hundred page PowerPoint deck ready to demonstrate how their product or service will “disrupt” the old, lazy incumbents in an industry and deliver riches to early stage investors. But actual disruption is rare. Organizations that have all the right ingredients to bring disruption to entrenched industries are very special and uncommon.

Every investor wants to understand disruption, whether from the perspective of the venture capitalist interested in spotting the next unicorn or the conservative investor worried that one of his companies might be on the receiving end of a tectonic industry shift. Safi Bahcall’s new book, Loonshots, is not a study of industry disruption per se, but it is useful for those who have an interest in the development of “crazy new ideas” that often end up being disruptive. He defines a loonshot as “a neglected project, widely dismissed, its champion written off as unhinged.” A moonshot, in contrast, is “an ambitious and expensive goal, widely expected to have great significance”. Loonshots often begin as embryonic ideas or technologies with no resemblance to the product or service that they later evolved into, and the inventors of the loonshot might have never imagined what the ultimate target market would be. Loonshots is a study of the nature of organizations that successfully nurture early “crazy ideas” that later turn out to have far reaching and often surprising implications.

The topic of loonshots can be approached in multiple ways. It is likely that most readers of this book are entrepreneurs or managers who are hoping to build or sustain highly innovative organizations. For these readers, the book offers a number of strategies that should be helpful for building organizational structures conducive to loonshots. Many readers of this article might be looking at the topic from the perspective of outside investors who want to identify companies that have characteristics necessary to nurture loonshots. In either case, a good understanding of the basic premise of the book is a necessary prerequisite.

Phase Transitions

The world is full of complex systems that exhibit sudden changes of behavior in response to slight changes to the variables that affect it. In physics and the hard sciences, a phase transition can refer to the transition point between a solid, liquid, or gaseous state of matter. A very simple example that everyone is familiar with involves water. Below 32 degrees Fahrenheit, a water molecule is in a solid state known as ice. Between 32 and 212 degrees, water takes on its familiar liquid state, and above 212 degrees, it turns into a gas and evaporates. The behavior of water close to 32 and 212 degrees represents a phase transition. Bahcall is a physicist who was trained to look at these type of phase transitions in the hard sciences and the key insight of his work is that he has adapted this mental model to the topic of organizational behavior:

There’s no way to analyze the behavior of any individual and explain the group. Being good at nurturing loonshots is a phase of human organization, in the same way that being liquid is a phase of matter. Being good at developing franchises (like movie sequels) is a different phase of organization, in the same way that being solid is a different phase of matter.

When we understand those phases of organization, we will begin to understand not only why teams suddenly turn, but also how to control that transition, just as temperature controls the freezing of water.

Loonshots, p. 12

At first glance, the idea of adapting rules governing the state of matter to complex human organizations seems suspect. “Physics envy” is a common affliction in social sciences, such as economics, where academics attempt to bring more structure and order to the human condition than is warranted in reality. However, Bahcall makes a strong case for his theory based on a number of case studies demonstrating the success of organizations that carefully managed phase transitions, as well as examples of those that did not. He shows that small changes in the structure of an organization, as opposed to its culture, can transform a rigid company into one that simultaneously fosters loonshots while also protecting its existing franchises.

Polaroid’s Rise

Edwin Land fits the modern prototype of a technology visionary, from his eccentric personality to his technical genius. It is easy to picture Land transported to the current age operating comfortably within the modern-day technology ecosystem. It is not an exaggeration to characterize Land as the Steve Jobs of his era, as Bahcall points out in his account of Land’s introduction of the groundbreaking Polaroid SX-70 in 1972. The Polaroid SX-70 was the first instant camera that was easy to use and had broad-based appeal to consumers. Those of us who grew up in the 1970s and 1980s can easily recall the ubiquity of these cameras and the instant gratification produced by having a print in hand in as little as a few minutes.

Bahcall’s fascinating account of the rise and fall of Polaroid begins during Land’s childhood half a century before the Polaroid SX-70 changed photography. Land was the prototypical child prodigy who experimented with complex scientific projects at an early age. At age 13, he became obsessed with creating a polarizer in order to “unlock the mysteries of light”, a goal that no one had yet achieved. By age 19, he had accomplished his goal. His love of the scientific process drove those early accomplishments, and only later did he turn his focus toward practical applications, such as coating car headlights and windshields with polarizing filters to reduce glare.

Land’s first big hit had a major impact on America’s ability to wage war. Polarized sunglasses improved the ability of soldiers and sailors to deal with the glare of sunlight and adjustable shade goggles helped pilots to quickly adjust during the transition from low light to bright conditions. Although Land’s invention did not provide as great a contribution as the invention of radar, which is another case study presented by Bahcall, it clearly helped allied forces during World War II and provided Land and Polaroid with financial success.

After the war, Land turned his attention toward the application of his technology to photography. After his three year old daughter asked “why can’t I see them now” after Land took some photos on a vacation, he had a “lightbulb moment” that led him down the path that eventually resulted in the Polaroid SX-70 instant camera thirty years later. And financial success followed as sales grew from less than $1.5 million in 1948 to $1.4 billion in 1978.

Types of Innovation

This is a good point to take a step back and consider Bahcall’s distinction between two distinct types of innovation. The innovations created by Edwin Land were product breakthroughs which Bahcall refers to as “P-Type Loonshots”. P-type loonshots are technologies that, at one point, were widely dismissed or viewed as not having practical value before finding an application and achieving success. Even Land himself had no idea that his childhood fascination with polarizers would lead him, half a century later, to introduce a groundbreaking technology that would change consumer photography forever.

In contrast, there are loonshots that involve a breakthrough in strategy. New ways of doing business or new applications of an existing product, without the use of breakthrough new technology, are called “S-Type Loonshots”. Bahcall points to the example of Sam Walton as an S-type innovator. Walton did not invent any new technologies, but he found a way to deliver products to consumers at much lower cost. The same is true of Herb Kelleher’s S-type innovation that led to the success of Southwest Airlines. And, surprisingly, Bahcall characterizes both Facebook and Google1 as S-type innovators as well since they did not invent the concept of social networks and search, respectively.

Both P-type and S-type loonshots are often characterized as crazy ideas that have no chance of working. Until they do. And the disruption caused by S-type innovation can cause havoc for firms that are led by P-type innovators who fail to manage their organizations in a way that both fosters continuing innovation while protecting existing franchises. Such was the case for Edwin Land and Polaroid.

Polaroid’s Fall

For three decades, Land’s leadership produced one product innovation after another:

Polaroid followed the first sepia prints in 1947 with black and white (1950); automatic exposure (1960); instant color (1963); non-peel-apart firm (1971); the SX-70 all-in-one, foldable camera (1972); sonar auto-focus (1978); and countless other advances in between.

Loonshots, p 109

Edwin Land was at the top of his game as a visionary genius and, in addition to his role as the driving technological force at Polaroid, he was also the man responsible for running the entire enterprise. Land loved technology and loved making risky product bets. He acted primarily based on his love of loonshots rather than focusing on the strengths of overall corporate strategy. Polaroid was falling into what Bahcall refers to as the “Moses Trap”, which he defines as follows:

When ideas advance only at the pleasure of a holy leader — rather than the balanced exchange of ideas and feedback between soldiers in the field and creatives at the bench selecting loonshots on merit — that is exactly when teams and companies get trapped. The leader raises his staff and parts the seas to make way for the chosen loonshot. The dangerous virtuous cycle spins faster and faster: loonshot feeds franchise feeds bigger, faster, more. The all-powerful leader begins acting for the love of loonshots rather than strength of strategy. And then the wheel turns one too many times.

Loonshots, p. 93

Land turned the wheel one too many times.

How many of you fondly recall family vacations saved for posterity using the Polavision home movie system? Probably very few people remember the system because it was a commercial failure. However, the product received glowing reviews2 at the time. Edwin Land had done it again. Except he had pushed the envelope too far this time. No matter how marvelous this P-type innovation was, it could not overcome the cost. The Polavision player retailed for $465, the camera cost $210, and each Phototape, which provided just two and half minutes of recording cost $9.95. Translated into 2019 dollars3, the basic system cost nearly $2,600 and each tape cost $38. Especially compared to median incomes at the time, this marvelous recording device was out of reach for the vast majority of consumers, no matter how great it was. However, in anticipation of commercial success, Land insisted on building a new plant to produce over 200,000 Polavision machines, and a film assembly line produced ample supplies of consumable Phototape cassettes.

The end of this movie followed in predictable fashion when Polaroid’s management was forced to write down the value of unsold Polavision inventory just one year after Land’s splashy introduction. Land’s comment that the accounting write-down “was accounting jargon, a cruel misuse of language” mirrors what modern-day visionary leaders often say on Twitter when faced with bean counters who stand in the way of their grand visions. Land had allowed his zeal for elegant P-type innovation to cost his company over $200 million. Even worse, as would be borne out in the coming years, he had entirely missed the move to digital photography even though he was aware of the technology. His passion was in film, and so were Polaroid’s profits. He was forced to resign soon after Polavision’s commercial failure.

Having Your Cake and Eating It Too

The world needs men like Edwin Land, and in more important ways than having the latest and greatest consumer technologies. Bahcall presents other fascinating case studies in the book regarding loonshots that had vital roles in the allied victory in World War II as well as medical marvels that have saved millions of lives. We need P-type innovators, and we need them badly, for society to progress in the decades and centuries to come.

Society might benefit from the Moses-type leader who creates groundbreaking P-type innovations regardless of financial consequences, but those of us who either run companies or invest in them also care about harnessing these type of innovators while also ensuring the long term survival of companies. How can we create “loonshot nurseries” while simultaneously keeping a company’s core franchise alive and well?

Bahcall provides practical advice to leaders that he refers to as the “Bush-Vail Rules”, inspired by the management philosophy of Vannevar Bush and Theodore Vail, both of whom are discussed early in the book. The Bush-Vail system involves four key rules, the first three of which are outlined very briefly below:

  1. Separate the phases. This goes back to the concept of phase transitions. It is extremely difficult for one organization to both come up with loonshot innovations and to operate an existing business. Bahcall advocates creating separate groups for “artists” and “soldiers” rather than hoping that they can coexist within the same organization. This involves more than opening up a loonshot office in a San Francisco loft. One must tailor the organization structure to the purpose. Generally, loonshot groups should be managed with a flatter organizational structure and looser controls while franchise groups benefit from a more centralized structure with stricter controls. Bahcall also believes that organizations should not focus exclusively on P-type innovations because doing so can create blindness to S-type innovations that can upend a franchise built exclusively on P-type innovations.
  2. Create dynamic equilibrium. A creative genius like Edwin Land naturally favors the “artists” while thinking less of the “soldiers”, as his attitude toward accounting write downs demonstrated. While it is not impossible for a creative genius to eventually love his “artists” and “soldiers” equally, doing so requires concerted effort. Bahcall notes that Steve Jobs, early in his career, was very much an Edwin Land style leader but through hard experiences, had a second act at Apple where he treated artists like Jony Ive and soldiers like Tim Cook as equally important. Bahcall recommends that the leader of an organization should manage the transfer of technology between the loonshot and franchise groups without excessive intervention which he likens to acting as a gardener rather than as a Moses.
  3. Spread a system mindset. Bahcall advocates maintaining a system mindset in which one is constantly asking why certain outcomes occurred, analyzing both success and failure, rather than taking a simplistic view. It is more important to analyze the quality of decisions than just individual outcomes. It is very possible for a good process to result in occasional bad outcomes, just as it is possible for flawed systems to occasionally create good outcomes. This notion is very similar to the second-level thinking that investors such as Howard Marks advocate.

Getting Past 150

The fourth Bush-Vail rule is one that I consider the most important and deserving of more in-depth discussion. It has to do with a number that I have seen mentioned in many places as having special significance.

That number is 150.

Yuval Noah Harari’s book, Sapiens, which I reviewed last year, observed that for much of human history, the maximum size of a society was approximately 150 individuals. This seems to be the maximum size of a group that can operate effectively in a cohesive society when the group relies primarily on personal relationships. Harari pointed out that only when society developed larger concepts such as nationality and religion could groups of individuals larger than 150 take on elements of cohesion required for large societies to survive.

Just as nationality and religion binds together very large groups of people, far in excess of a couple of hundred, it is possible for companies to bind together larger groups as well. However, anyone who has been involved in companies of radically different sizes knows that small companies have dramatically different structures and cultures compared to large companies.

In a small company, the management span tends to be very wide – meaning that there are few layers of management between the CEO and individual contributors. The nature of small companies also creates an environment in which the incentives of individuals is to focus intently on the success of the overall organization and its mission. What difference does it make if one maneuvers politically in an organization in which there are few layers of management and survival depends on the success of the project?

In a larger company, management span tends to be narrower – meaning that there are many layers of management between the CEO and individual contributors and the number of direct reports for each manager is lower. The line of sight between the success of an individual’s project and the success of the company is much more diffused. There is a higher return for those who can maneuver politically because there are more layers of management and, typically, the pay gap between layers is larger than in a small start-up.

As an organization increases in size past the 150 mark, Bahcall believes that a phase transition typically results in which an organization shifts from one that is conducive to producing loonshots to one where the return on politics begins to exceed the return on actual achievement. However, he believes that there are a number of ways to raise this “magic number”. Still, beyond a certain size, a group will inevitably shift from a “loonshot mindset” to a “franchise mindset”, and this is why it is important to nurture your loonshot nursery as well as your franchise groups and to deftly manage the transition between the two.

“Here’s to the Crazy Ones”

Loonshots provides fascinating case studies that show beyond any doubt the returns to society that come from the types of people Steve Jobs would often call “the crazy ones“.

Jobs himself is a case study in how a “crazy one” can evolve from a Moses-like figure similar to Edwin Land into the executive who found a way to successfully manage loonshots while also sustaining his company’s core franchise. Today, Apple is run not by an “artist” but by a “soldier”. Tim Cook is an operational genius, not a product visionary, yet he has so far seemed adept when it comes to sustaining the “loonshot nursery” at Apple. With the recent departure of Jony Ive, Cook’s job has become more difficult. It will be fascinating to see how Apple evolves over the next decade.

Dan weighs his options. His bonus is based on something the company’s CEO mysteriously calls “community adjusted EBITDA” for the current quarter and he is one of three hundred engineers in a company of ten thousand employees. He has no clue what “community adjusted EBITDA” even means or how his project’s success will influence it. There is only one level of management between him and Janet – his direct supervisor – and rising up just one level in the hierarchy would mean a raise of around 30 percent. Dan saw his manager browsing LinkedIn before the meeting and has a feeling that his boss is looking for a new job. Dan decides to walk over to the coffee machine and strike up a conversation with Janet about the new principal at their kids school. After taking with Janet for 15 minutes, Dan leaves the office to catch an early train home, feeling good about his relationship with Janet and his prospects for promotion.

  1. I am not sure that I agree with Bahcall in the case of Google. While search existed before Google, one can argue that the utility of search before PageRank was limited and that Larry Page’s invention was a P-type innovation. []
  2. Polavision was hailed as a technological marvel, with the reviewer clearly in awe: “Once put into the player (like stuffing a slice of bread into a toaster), the Phototape is whisked to its starting position and, within 90 seconds, the fully developed color image appears on the screen via light shining through a prism in the cassette. The player produces an amazingly bright image, easily viewed by several people in either daylight or a darkened room.” []
  3. Source for conversion of 1978 dollars to 2019 dollars: BLS CPI Calculator []

The Case for Non-Consensus Active Investing

“Research is a quest for truth, not a confirmation of predetermined beliefs that we have concluded to be true. It must be conducted without an agenda. You should not care what truth will be revealed, as long as your process reveals the truth. Investors who go about their research to validate a preset conclusion are doomed to fall into the confirmation trap.”

— Rupal J. Bhansali, Non-Consensus Investing, p. 175

In Garrison Keillor’s fictional Lake Wobegon, “all the women are strong, all the men are good-looking, and all the children are above average.” We chuckle at the absurdity of the notion that an entire population can somehow be “above average” because, of course, this is not possible. Yet what is sometimes known as the Lake Wobegon Effect is alive and well in many facets of life.

Most drivers are convinced that they are well above average. A recent survey revealed that ninety percent of parents think that their child is above average. These types of misconceptions are known as illusory superiority, a cognitive bias that impacts many aspects of human life. We know that the vast majority of other people must, by definition, cluster near average, but we most certainly are not part of that run-of-the-mill group.

One of the reasons that people fall victim to illusory superiority is because human beings have an innate need to feel good about themselves. No one wants to believe that they are average or below average, especially in an area that they closely associate with their personal or professional identity. Maslow’s Hierarchy of Needs places self-esteem fairly high up on the pyramid and it is definitely a prerequisite for happiness. Almost everyone wants to be respected by others and, even more importantly, wants to achieve a certain degree of self-respect. No one has any desire to view themselves as inferior or incompetent.

The Hollywood stereotype of Wall Street would lead outsiders to believe that traders and investors are hyper-confident people certain of their ability to compete and win. Sometimes Hollywood stereotypes are not that far from the mark because it is rare to meet an investment professional who projects any hint that he or she is anywhere near average. After all, the role of active investment management is to compete, win, and significantly outperform the averages. An investor who is not able to prove above average skills will not be able to justify management fees and will eventually be out of a job.

While the need to outperform, and consequently to have high self-esteem, is ever present, we should bear in mind that human beings have even more fundamental needs related to safety and belonging. In the field of investing, it is very common for professional investors to cluster around commonly held beliefs and ideas because it is much more comfortable to be in agreement with others than to offer divergent views in opposition to the best loved beliefs of your peers. If you fail on Wall Street, it is much better to fail conventionally with everyone else than to take divergent non-consensus views and fail unconventionally. This leads the vast majority of investors to take on consensus views most of the time and results in dysfunctional behavior such as closet indexing that fails to add any long term value.

Rupal Bhansali advocates a far different path for active management in her new book, Non-Consensus Investing: Being Right When Everyone Else Is Wrong. While not against passive investing per se, Ms. Bhansali believes that there is a far better approach that makes it possible to do what academic theory argues is impossible: increasing returns while lowering risk. We all want to outperform passive indexes and any investor who has been around through multiple market cycles is aware of the need to contain risk. The ability to construct a portfolio of investments that outperform the market and carry a lower risk of permanent loss of capital could be viewed as the holy grail of investing. However, unlike a quest for an ancient relic, there are well understood principles that increase the probability of achieving the holy grail of investing. This book presents Ms. Bhansali’s approach to escaping the average and achieving meaningful outperformance.

Active vs. Passive

The fact is that any investor has the ability to match the market by using index funds. John Bogle, the inventor of the modern index mutual fund, was a relentless crusader for giving ordinary investors the ability to at least match market returns. Active management holds out the promise of either achieving market returns with demonstrably lower business risk or exceeding market returns without taking on much higher risk (or, better yet, taking less risk). At the time of Ms. Bhansali’s writing in November 2018, index funds had nearly reached fifty percent of U.S. stock fund assets. Passive index funds went on to exceed active funds based on assets under management in September 2019.

Ms. Bhansali believes that passive investing is becoming a “crowded trade” due to its amazing success in attracting assets in recent decades. She believes that this dominance has caused a number of risks to build up that are not commonly understood. Furthermore, she believes that the overall valuation level of stocks at the current time make it likely that passive strategies will provide only paltry returns in the future that will be insufficient for individuals and institutions that require greater returns.

Just because investors may “need” higher returns does not mean that the markets will give it to them, but Ms. Bhansali believes that it is important to invest actively in order to have a reasonable shot at decent returns in the years to come. One reason active strategies may become more viable in the future is that index funds could be causing various types of market inefficiency due to the mandate these funds have to own securities regardless of valuation. Active managers can monitor management behavior and hold their “feet to the fire”, and the actions of such managers increase market efficiency. In recent years, activist investors have done much to improve the operations of specific companies. The incentive to do this was to achieve outperformance. It is difficult to imagine even very large passive investors taking on activist roles and pressuring management because they have no incentives to do so – they are simply paid to match an index, not to improve returns.

The Ability to Stand Apart

Many investors confuse voluminous knowledge of facts and figures with differentiated insight. The problem is that merely knowing all the information about an industry or company does not provide a meaningful edge over other market participants, especially in the case of crowded trades.

“Markets do not reward research that discovers or proves what others have already discovered or proven. All the midnight oil burnt; frequent flyer miles logged; and arduous meetings with management, suppliers, customers, and competitors to conduct fundamental research amounts to zilch if you do not uncover anything new or different. Active investors who are unskilled in their research efforts are rightly facing an existential wake-up call: differentiate or die. It is not a market conspiracy but a market objective to weed out such undifferentiated active investors who add transaction costs in the form of high fees for their efforts but generate no value.”

Non-Consensus Investing, p. 45

Ms. Bhansali correctly observes that an investor must first be a business analyst and then a financial analyst. Many investors get this backwards. They seek to know every data point about a business but they do not go beneath the numbers to identify why a company has been successful or has run into trouble. Understanding financial data points is necessary to make good investment decisions but it is not sufficient.

BlackBerry and Apple

One of many brief case studies in the book involves the story of Research in Motion, the company behind the wildly popular BlackBerry device. Millennials may have only the vaguest memories of BlackBerry, but those of us in the business world during the first decade of the century recall what a cult following these devices had. They were must-have accessories because the reliability and security of BlackBerry was unmatched and there were no real substitutes.

Those who focused only on data points found the RIM story fantastic. The stock was roughly a 100-bagger over a span of less than six years through mid 2008. However, improvements in cellular networks, competing technology, and the emergence of smart phones made BlackBerry’s competitive advantages irrelevant. Investors who focused only on facts and figures did not act as business analysts. The question of why metrics such as profit margin and market share were high was not asked by many investors until it was too late.

Could investors have identified risks in the BlackBerry story early enough to escape the carnage in the stock that took place once the handwriting was on the wall? The book contains a number of questions that enterprising investors should be asking to get behind the numbers and understand the underlying drivers of the business. In particular, Ms. Bhansali provides a number of “myths and truths” about quality that can help investors differentiate between the real thing and value traps.

Will Apple’s cult-like following and seemingly impregnable moat be disrupted in a manner reminiscent of BlackBerry? This has been on the minds of many investors lately, especially as Apple shares have reached new record highs taking the market capitalization of the company to nearly $1.2 trillion in November 2019. Ms. Bhansali looked at the company in the 2017-2018 timeframe and came away unimpressed for a number of reasons. She views Apple as a mature consumer electronics company with single-product risk due to continued heavy reliance on the iPhone. Although the average selling price of new iPhones has been increasing in recent years, the frequency of replacement has declined and developed markets appear to be saturated while Apple has little to offer emerging market consumers at a price point they can afford.

Ms. Bhansali is not overly impressed with the pivot toward services revenue because the driver for such revenue continues to be correlated to the number of devices that are sold. If the installed base of iPhones shrinks, so would service revenue opportunities and she worries that this could cause Apple to become a melting ice cube. Importantly, she points out that there is no need for Apple to fail in order for investors to get hurt. All it would take to cause a significant fall in the stock price would be a moderate revenue decline coupled with declining margins. The resulting lower earnings would break the growth story and likely cause the earnings multiple to decline.

Of course, Ms. Bhansali may or may not be correct about Apple’s prospects. Obviously Warren Buffett would strongly disagree with this assessment! The important point, however, is that Ms. Bhansali is focusing on business drivers that are behind the reported numbers. She is asking the ever-important “why” questions regarding Apple’s current dominant position and attempting to formulate a non-consensus view.

Think Different

One of Apple’s most successful advertising campaigns was a celebration of people who “think different”. There might be safety in numbers and warmth in the middle of the herd, but those who seek to be an exception in any field of human endeavor must strive to be different in some way. Of course, the risk of being different but wrong is ever present. Being different is not a guarantee for success, but following the herd implies guaranteed mediocrity.

Ms. Bhansali urges active investors to “think different”, to dare to buck the comfortable consensus and come up with differentiated insights that have a chance of generating outperformance. Her book provides a number of valuable insights regarding how to go about the research process in a way that is likely to uncover non-consensus views and, even more importantly, how to control risk and avoid common traps. A healthy degree of self-confidence is essential for accomplishing any of this in the field of investing, but the same is really true in any field.

So … Active or Passive?

Should investors who lack either the interest or capability to implement a non-consensus strategy adopt a passive approach or look for a manager who has what it takes to outperform? Ms. Bhansali believes that the passive approach is unlikely to deliver the kind of returns that most investors need in the years to come. But is it possible to identify managers who can deliver better returns in advance? There is no doubt that such managers exist, but we do not know whether the successful managers of the past will be successful in the future. The risk is that one picks an active manager who goes on to underperform. If that happens, the paltry returns on offer from a passive strategy might seem desirable in comparison.

My own non-consensus view is that the vast majority of Americans would be best served by lowering their expectations and doing so with equanimity. The American household earning the median income lives a lifestyle that an American living a century ago would look upon with amazement and envy. Those of us with greater resources are even more fortunate, but still rarely satisfied. The problem is that the hedonic treadmill leads people to never be satisfied with what they have. To some degree, the quest for an ever-improving life is the American way, but this can be taken to excess and can lead to unhappiness. Most people would do well to lower their consumption, increase their savings rate, and dollar cost average into broad based index funds over a long lifetime. In fact, Warren Buffett, the greatest investor of the past seventy years, suggests that people should do exactly that.

Disclosure: The Rational Walk LLC received a review copy of this book from the publisher.

The Hazards of Talking to Strangers

“So, guys, how did the trip to Japan go? Did you get the software installed?”

“It was great! The clients loved us and are super happy about the installation! The boss even took us out for dinner the last night and we stayed out later with some of the younger guys on the team who showed us around the Ginza District. They are super happy!”

The project was a dismal failure.

The Japanese clients could not properly read the fonts that were selected for them by the young engineers from Silicon Valley. And that was the tip of the iceberg. The system simply did not offer the functionality that the client had in their old system, to say nothing of the improvements they were hoping for.

Somewhere along the line, signals were crossed and the strangers from two vastly different cultures could not find a way to communicate effectively. Even worse, both sides did not realize that they were not communicating effectively. The American team thought that the Japanese clients were happy. The Japanese clients thought that the American team understood that the project had failed.

Why is it that we often seem to misread people we don’t know well, even when we share the same culture and background? The implications of this question are far reaching and go well beyond committing a minor faux pas at a party or the failure of a software installation project. Misreading others has often been the cause of military conflicts costing thousands of human lives. Given the high stakes involved, psychologists have long searched for answers regarding how humans communicate and the pitfalls that can occur when signals are crossed and communication fails. Malcolm Gladwell, who is perhaps best known for his previous bestselling book, Outliers, has written a new book in search of answers to these vexing questions. Talking to Strangers is Gladwell’s attempt to survey the field and come up with answers, starting with the case that seems to have haunted him the most: The arrest and subsequent suicide of Sandra Bland.

The Black Lives Matter movement is only about six years old but has become a rallying cry for those who believe that our society is not acting quickly enough to address systemic racism. Gladwell opens his book with a description of what took place in Prairie View, Texas between Bland, a young African American woman, and Brian Encinia, a young Hispanic police officer. After pulling Bland over for a minor traffic violation, the situation spirals out of control when Encinia responds to Bland’s irritated demeanor by ordering her out of her vehicle. Bland resists, a physical altercation ensues, and Bland is arrested and jailed. Three days later, Bland committed suicide in jail.

Gladwell is clearly haunted by this episode and its implications. All of the stories and examples he covers in the book, from examining how longtime spies could permeate American intelligence agencies to how Neville Chamberlain could so badly misread Adolf Hitler to how Bernie Madoff could defraud investors for decades, seem to lead up to his concluding chapter revisiting the Sandra Bland tragedy.

Truth-Default Mode

One of the core insights Gladwell asserts early on is that people are not good at detecting when others are telling the truth. The core problem seems to be that we assume a greater level of transparency in other human beings than we see in ourselves:

“We think we can easily see into the hearts of others based on the flimsiest of clues. We jump at the chance to judge strangers. We would never do that to ourselves, of course. We are nuanced and complex and enigmatic. But the stranger is easy. If I can convince you of one thing in this book, let it be this: Strangers are not easy.”

But isn’t this obvious? Who thinks that strangers are easy? Very few of us, especially those of us involved in the investing field, would characterize ourselves as gullible about the intentions of others. However, Gladwell makes convincing arguments that even those who are trained to be skeptical are often lulled into a false sense of security by what he refers to as the “Default to Truth”.

The case of Ana Montes provides good evidence that most of us are likely to have serious blind spots. Montes was a longtime spy for Cuba and worked as an analyst for Defense Intelligence Agency. She fell under suspicion in 1996 when a series of events caused counterintelligence agents to focus on her activities. Scott Carmichael, a highly trained DIA counterintelligence agent, questioned her at length and she denied the allegations. Carmichael was convinced of her innocence even though, years later, he would reflect on several warning signs related to Montes’s responses and her demeanor. It turned out that Montes was a Cuban spy and had been for nearly her entire career. She had met with Cuban handlers at least 300 times. Her brother and sister both worked at the FBI and had no idea of her betrayal. Her treachery was finally detected four years after Carmichael first interviewed her — after countless other national security secrets were given to the Castro regime.

Gladwell asserts that human beings tend to default to truth – that is, we tend to view other people as relatively transparent and give them the benefit of the doubt. This approach is not without its benefits because society cannot function in an environment where there is no baseline of trust. Most people require a trigger to snap out of “truth-default” mode. In general, we fall out of truth-default mode only when the case becomes definitive. As was the case for Fox Mulder in the X-Files, most of us “want to believe”. If this tendency caused a trained DIA counterintelligence agent to explain away the fidgety demeanor and shaky story of Ana Montes, what hope do the rest of us have? Bear in mind that we are referring to the ability to detect truth in individuals within our own culture and society. The problems multiply manifold when interacting with those who we share little in common with.

Default to Skepticism?

What is the antidote to the many problems that are caused by truth-default mode? Can we train ourselves to be skeptical about others and only come to the conclusion that something is true when presented with evidence? This is the approach many of us in the investment community try to take. Perhaps the most famous recent example is the case of Harry Markopolos who was one of the very few individuals to detect Bernie Madoff’s massive fraud years before Madoff’s Ponzi scheme collapsed in 2009.

Markopolos had been watching Madoff’s activities for years and warned the Securities and Exchange Commission repeatedly starting in 2000. All warnings were ignored. Markopolos did not default to truth – he did not care that Bernie Madoff was well respected on Wall Street or that his reported results were excellent over a long period of time. Markopolos looked at the facts and they did not add up. Markopolos did not trust the system and assumed nothing.

Markopolos did not require a high threshold to be jolted out of truth-default mode. He had no threshold at all. However, Markopolos is very unusual and his distrust of the system comes at a cost. He detected the Madoff fraud but, according to Gladwell, he was constantly paranoid and on edge, insisting that his life was in danger and living in what sounds like an armed compound. It is unclear whether the kind of skepticism demonstrated by Markopolos is an innate personality trait or whether we could train ourselves to behave in that manner. In either case, however, it is not obvious that defaulting to skepticism is desirable. Doing so comes at a high cost to the individual.

Returning to the case of Sandra Bland at the end of the book, Gladwell believes that the situation escalated out of control primarily because the police attempted to adapt a policing strategy that had worked in certain locations with a high concentration of crime but was inappropriate for Prairie View. The premise behind this strategy was to train officers to overcome their default to truth and actively look for things that appeared unusual or suspicious in the conduct of others. Additionally, the police had adopted a strategy of pulling over motorists for very minor infractions in order to observe behavior and consider whether the pretext existed to search vehicles. Sandra Bland’s irritation with being pulled over, coupled with her out-of-state license plate resulted in the officer becoming suspicious of her situation. Bland refused to follow instructions, Officer Encinia forced her out of the car, and she was arrested. The outcome was tragic as a young woman with a history of depression took her own life in prison.

Gladwell’s treatment of this case is bound to cause controversy. Should police officers “default to truth”? It would be naive to suggest that police should not be skeptical and constantly aware of potential crimes. After all, law enforcement is about protecting and serving the public. However, Gladwell asserts that the tactics that work in very specific high crime areas, down to a city block, do not work well in a broader context. Ironically, although Gladwell appears to have been inspired to write this book based on the tragic case of Sandra Bland, his argument with respect to police behavior may be the least persuasive part of the book. He is much more convincing in his discussions regarding spies, Bernie Madoff, and Chamberlain’s appeasement of Hitler.

What Happened in Japan?

Back to our opening anecdote. What in the world happened in Japan? The story took place in early 1998. All of the software engineers were young men who had grown up in California and were steeped in its informal culture. This was also a time of frenzied activity in the technology industry with companies being founded and going public constantly. Success and optimism, coupled with a very direct communication style, characterized Silicon Valley technology firms during that era.

Japan, on the other hand, was a tradition-bound culture with a complex set of rules and business etiquette. Society, both in family life and in the workplace, was defined by clear hierarchies and protocols. It could hardly have been more different from the culture and ethos of Silicon Valley. However, both the Americans and the Japanese assumed transparency when interacting with their counterparts. But in addition to the problems inherent in assuming transparency in general, they were viewing their counterparts through the lens of their own culture.

In American business culture, if you have hired a consulting firm to install software for your business and the users cannot clearly see the fonts or access the expected functionality, you would most likely be very direct and make it clear that the results are unacceptable. This would be obvious through your demeanor and your words. In Japanese business culture, the cues appear to be more subtle and not at all direct. In addition, etiquette such as hosting a guest for meals or tea is a ritualized experience not necessarily dependent on how happy the host is with the visitor.

The outcome of this story is that the problems were eventually worked out, but it took much longer and cost much more than it would have had the individuals understood each other. Gladwell’s examples are all far more serious than the problems encountered by software engineers operating in a foreign culture, but the underlying principles seem to hold. We often misunderstand others and pay the price for it.

Gladwell’s book is more useful for pointing out these problems than for coming up with strategies and solutions to counteract them. Nevertheless, there is value in being aware of the hazards of talking to strangers and at least recognizing where the consequences of misunderstanding are likely to be greatest. Trusting each other, to a certain degree, is required for modern society to function at all. However, we should be aware of situations in which our tendency to default to trust could carry very high consequences if we are mistaken. A certain degree of skepticism when facing very high stakes situations is simply being prudent. We need to figure out when to emulate Harry Markopolos and, perhaps more importantly, when not to.

The Paradox of Trust

“We have listened to the wisdom of an old Russian maxim, doveryai, no proveryai – trust, but verify.”  

— Ronald Reagan

Trust is the foundation of society. Without a basic level of trust regarding the intentions and expected behavior of other human beings, our modern civilization would very quickly disintegrate into total chaos. If you need to be convinced regarding this basic premise, consider your activities over the past day. Chances are that you made countless implicit decisions to trust other people, whether you realized it at the time or not, and misplaced trust would have produced severely negative consequences.

Did you take the subway to work this morning? You trusted that the dozens of people standing nearby on the platform would not push you from behind onto the tracks. Maybe you stopped for a sandwich at the deli near your office. You trusted that the person who prepared your food practiced basic hygiene and did not sneeze over your food or, even worse, purposely contaminate it, and you trusted that the food supply chain was safe. For something that is about as personal as it gets – food that you ingest into your body. After work, you stopped by the local barber for a haircut and shave. You trusted that the barber had the skill to use that straight blade near your neck, and that he was not a murderous lunatic who would slit your throat.

It would be ridiculous to consider every one of these possibilities in day to day life. Your life would grind to a halt, and your mental state would be in tatters as you see threats lurking around every corner. And if everyone in society felt the same way, the consequences would grow exponentially. We need a certain level of trust in society to function as individuals and for the system to remain intact. A civilization that falls below a certain level of trust will descend into anarchy.

Trust in Society

Relatively small groups of people can form cohesive groups and social hierarchies based on close personal relationships and communication within the group. In his best-selling book, Sapiens: A Brief History of Humankind, Yuval Noah Harari pegs the upper limit of social cohesion based on such personal relationships and “gossip” at approximately 150:

Even today, a critical threshold in human organizations falls somewhere around this magic number [150]. Below this threshold, communities, businesses, social networks and military units can maintain themselves based mainly on intimate acquaintance and rumormongering. There is no need for formal ranks, titles and law books to keep order … But once the threshold of 150 individuals is crossed, things can no longer work that way. You cannot run a division with thousands of soldiers the same way you run a platoon.

Sapiens: A Brief History of Humankind, page 27

Harari believes that larger groups are able to function based on what he refers to as the “appearance of fiction”. This is described in more detail in this excerpt from our review of Sapiens:

Fictive language involves the ability to use imagination to describe things that are entirely abstract.  The concept of religion, for example, describes a set of beliefs that cannot be observed by ordinary human beings but, nonetheless, allows humans to form a common set of beliefs and customs.  Without fictive language, it is difficult for groups larger than about 150 individuals to form a cohesive society because they lack the ability to develop “fictions” that bind together larger populations.  The development of the notion of religion and nationality allowed much larger groups of humans to form social bonds.  

Harari’s use of the term “fiction” in the context of religion is unfortunate, but for our purposes we can simply regard what he is saying to mean that society on a large scale requires common value systems in order to properly function. Without these value systems, it would have been impossible to scale society beyond the tribal level. The concepts enshrined in religion and national identity allow individuals to assume a certain set of common beliefs when encountering strangers — to trust that strangers are very likely to behave in certain ways.

The written and unwritten rules of the road, established formally by governments and religions and informally through social conventions and habits, governs how we all interact with each other on a daily basis and what baseline expectations we have. Outside of deeply dysfunctional communities, in the United States most of us assume that those we meet on the street or in casual business contexts are basically honest and mean us no harm. This is why we can wait for a subway train, eat a sandwich, or have our hair cut without suffering a panic attack.

A Moral Imperative

Charlie Munger has often stated that it is a moral imperative to act in a rational manner and for those in charge of important institutions to create systems that promote rational and honest behavior. In other words, those who are entrusted with political and economic power must do their utmost to maintain an environment in which trust continues to exist.

The highest form which civilization can reach is a seamless web of deserved trust. Not much procedure, just totally reliable people correctly trusting one another.

Charlie Munger, USC Law School Commencement Address, 2007

Such a seamless web of deserved trust is extremely rare in today’s world but, if attained, can produce tremendous dividends. For most of us, at least for the fortunate among us, a seamless web of deserved trust is reserved for very close family members and friends but not often extended to coworkers or employers.

In Mr. Munger’s case, the seamless web of deserved trust extends into his professional life and sixty year business partnership with Warren Buffett. It is unlikely that a large society can ever approach that level of trust, but we must at least comfortably surpass the threshold needed for society to function reasonably well. At the very least, institutions should avoid creating systems that promote distrust. Perverse systems are much more common than one would expect.

The Cash Register

Consider the case of Eve, a woman who is well liked within her small community, active within her church, and seen as a solid employee and citizen by those in positions of authority. Eve was widowed at an early age, lives with her three pre-teenage children, and works paycheck-to-paycheck as a general manager at local small business. It is early November and Eve suddenly falls ill and is unable to work for several days. Her employer feels too financially insecure to offer any kind of paid leave so this sets Eve back financially. She’s able to cut back on enough spending in November to pay her rent on December 1 but is flat out broke heading into the Christmas season. She’s ashamed that she took a turkey and a few other groceries from the store for Thanksgiving dinner, but that seemed like a minor one-time indiscretion.

Eve’s employer is an elderly man who has owned the small market on Main Street for well over a half century and he has known Eve since she was a child. The business is run on a cash basis and there is no real inventory system in place. Most customers are known to Eve and some of the older folks still run a tab with the store. There are no barcodes on products, there is no scanner, and Eve uses a hand calculator to total up orders, accepts cash, puts it into a drawer, and takes cash out of the drawer to make change. The old man might come into the store every few days to socialize at the counter with old friends but he has long spent most of his days on the front porch of his house on the outskirts of town. Other than Eve, the store has a handful of part time employees who are mostly the grandchildren of the old man’s friends.

It is obvious that this type of scenario is tailor made to create massive temptation on the part of Eve and other employees to steal from the old man. She could steal inventory easily because there is no system in place to track what should be on the shelves. She could steal cash from the drawer. There is no real limit beyond her inherent honesty and, heading into Christmas flat out broke, her willpower gives in and she steals food and enough money to buy presents for her children.

In Charlie Munger’s worldview, the store owner has acted in an immoral manner. He was a man in a position of authority within the community and he failed to establish systems in which virtue and honesty are promoted within his business. Eve was wrong to steal, regardless of her situation, but the old man also had a responsibility as the owner of the business to promote good behavior even if he did not particularly care about the theft. Tempting an otherwise decent person to act immorally is itself immoral.

Obviously, the scenario here is a fantasy in today’s world. Almost no business would be run in such a lax manner. But this was the norm in the late nineteenth century. Temptation was rampant in retail businesses because there were few effective controls to promote trust. This began to change with the invention of the cash register:

The cash register did more for human morality than the congregational church. It was a really powerful phenomenon to make an economic system work better, just as, in reverse, a system that can be easily defrauded ruins a civilization. A system that’s very hard to defraud, like a cash register, helps the economic performance of a civilization by reducing vice, but very few people within economics talk about it in those terms.

Charlie Munger at U.C. Santa Barbara, 2003

Like many other inventions that change the world, the inventor of the cash register was not the man who popularized its use. James Ritty owned a saloon in Dayton, Ohio and suffered a great deal of theft from employees. Facing this “shrinkage” of inventory and outright thefts of cash, Ritty developed a machine that he referred to as an “Incorruptible Cashier” and filed a patent for the invention in 1883. John Patterson was one of the early customers of this new invention and saw the potential more clearly than Ritty. Patterson purchased the patents from Ritty and went on to found National Cash Register which dominated this market for decades to come. By 1915, the cash register was an essential piece of equipment for nearly all retail establishments.

It is obvious that the cash register reduced the temptation to steal from retail businesses, but how did it do so? It increased the perceived cost of theft by increasing the probability that one would be caught. By doing so, it also keeps fundamentally honest people honest by removing the temptation to act immorally in a way that carries little risk of detection. One might wonder how employees reacted to early versions of the cash register. Did they operate in a seamless web of deserved trust if the owner of a business felt a need to introduce this type of technology?

A Seamless Web of Suspicion

Let’s fast forward about a hundred years to the present time, nearly one-fifth of the way through the twenty-first century. Technology has advanced by leaps and bounds which allows for checks and balances that James Ritty and John Patterson could have only dreamed about. Over the past 150 years, we have gone from a world where almost nothing could be monitored without human eyes and ears to a world where literally every movement of every individual can be tracked and recorded. In the context of a private business, video cameras and facial recognition software can be used to track known shoplifters and to serve as evidence in criminal cases. Employees are under constant surveillance as they do their jobs and any kind of theft is far more risky than anything Eve could have contemplated.

For all of its intrusiveness, video cameras and facial recognition are relatively invisible technologies allowing people to go about their daily lives imagining that they are not being closely monitored. However, certain retailers have taken very visible steps to deter theft. For example, Wal-Mart has implemented increasingly drastic security measures recently. Initially, locked shelves for small, high value products such as razor blades were introduced. When one wants an item from a locked shelf, it is necessary to find a store employee to unlock the cabinet. This creates an environment of distrust and inconvenience.

Over time, my local Wal-Mart has added locked shelves for products such as deodorant, bath soap, over-the-counter drugs such as Tylenol, home cleaning products such as laundry detergent, and more. On my latest visit, the underwear section was entirely locked up. These are products that sell for $10-20 and are bulky. It is one thing for someone to steal a $20 packet of small razor blades and quite another to attempt to steal a twelve-pack of briefs or a 100 count bin of Tide Pods.

The seamless web of suspicion continues with very obvious facial recognition and video recording at the self-checkout registers. Wal-Mart has increasingly substituted capital for labor in its stores even in regions where the minimum wage remains at the relatively low Federal floor of $7.25. Customers are now the workers responsible for scanning their own purchases, and you are told that you are being watched and can even see an image of yourself as you check out. The cash registers of 1900 are nothing compared to these technological marvels of the twenty-first century. The final strand in the web of distrust occurs as you are leaving the store where an employee is stationed to inspect your cart and your receipt to detect signs of theft.

When I posted some of these details about my recent Wal-Mart experience on Twitter, I got my share of snarky responses regarding my neighborhood. Granted, this Wal-Mart is not in the best of neighborhoods but it is the closest Wal-Mart to my home and only four miles away. What is interesting is that the Walgreens on my street, in a much better neighborhood, has also started to lock up products in recent months including laundry detergent. The web of distrust seems to be spreading. And it might be bad for business. I would rather order underwear on Amazon than ask an employee at Wal-Mart, if I can even find one, to unlock a shelf. In a low-margin retail business, perhaps the calculation is that shrinkage is so costly that giving up on sales due to customer frustration is an acceptable trade-off.

Where is the Balance?

All of this brings us back to the essential role of trust in a functional society. Is it realistic to ever approach the “seamless web of deserved trust” idealized by Charlie Munger? The cash register was clearly a major advance in human civilization because it promoted virtue and discouraged vice, but what about modern advances in technology? If the cash register of 1919 was a positive impact on society and did not create an environment of distrust, why would the modern equivalent of monitored self-checkout registers be a problem in 2019?

A possible way to think about this question is to acknowledge that new technology almost always causes suspicion when it is introduced. If the old man who owns the market suddenly installs a cash register and inventory system at his store, Eve might think that her employer does not fully trust her. However, in due course, the cash register will become a familiar part of her work life. It also makes her job much easier and this is, in fact, the primary benefit of the technology. In addition to increasing her productivity, the register encourages her to live up to her true nature as an honest person.

Perhaps we can then differentiate between technologies such as background facial recognition and monitoring at self-checkout lanes and steps such as locking up products behind secure shelves. The former might eventually fade into the background and not be seen as an element of distrust. But the latter will never be seen by customers or employees as anything other than a sign that Wal-Mart or Walgreens distrusts those who they do business with. When there is distrust, people begin to question motives such as in the case of a Wal-Mart that locked up products commonly purchased by African-Americans while leaving other products out in the open.

Society should strive for systems that promote trust and keep people honest while avoiding systems that encourage people to think that everyone around them is dishonest. Trust is fragile and when society is full of cues that lead people to believe that no one is to be trusted, this can very well become a self-fulfilling prophesy. Striking the right balance is difficult but essential and the political, business, and community leaders in a society have a moral duty to get it right.

Avoiding 21st Century Twaddle

“Man, as a social animal who has the gift of language, is born to prattle and to pour out twaddle that does much damage when serious work is being attempted. Some people produce copious amounts of twaddle and others very little.”

— Charlie Munger, The Psychology of Human Misjudgment

We have all come across people who somehow always seem to soak up our time, break our state of flow, and generally act as impediments to getting anything meaningful accomplished. When Charlie Munger gave his now-famous speech regarding psychological misjudgments nearly a quarter century ago, most of these distractions took place in person or over the telephone. Today, we have infinitely more opportunities for twaddle induced distractions due to our constant state of connectivity. The number of distractions that can impede serious work has risen exponentially. Achieving anything meaningful in life requires avoiding twaddle as much as possible, both in terms of generating it and being subjected to it. Like most things, this is easier said than done. How can we avoid twaddle and preserve our state of flow?

Charlie Munger started his professional life as an attorney who made a living billing clients for legal work. The legal profession is known for its focus on producing as many billable hours as possible. If an individual attorney in private practice wishes to increase his or her income, the two levers to do so are to increase the number of hours billed or to increase the hourly rate. At an early age, Mr. Munger grew dissatisfied with the limitations of billing people for his time:

“I had a considerable passion to get rich. Not because I wanted Ferraris — I wanted the independence. I desperately wanted it. I thought it was undignified to have to send invoices to other people. I don’t know where I got that notion from, but I had it.”

Charlie Munger, The Snowball, pages 226-227

Diligence and hard work as an attorney will eventually lead to a higher hourly rate and more legal work and this will lead to higher income. However, this type of work has inherent limitations because it depends on a finite resource: the limited hours of an individual human being. Having the desire to increase his wealth exponentially, Mr. Munger started a legal practice in which he and his partners employed associate attorneys and he also began investing his capital in real estate ventures. How did he find the time to do this while also continuing to bill clients in order to support his large family?

“Charlie, as a very young lawyer, was probably getting $20 an hour. He thought to himself, ‘Who’s my most valuable client?’ And he decided it was himself. So he decided to sell himself an hour each day. He did it early in the morning, working on these construction projects and real estate deals. Everybody should do this, be the client, and then work for other people, too, and sell yourself an hour a day.”

Warren Buffett, The Snowball, page 226.

The mindset of considering yourself to be your most valuable “client” is incredibly important. It recognizes the fact that the only way in which you can leverage your financial outcome is buy not selling all of your time to others. Even more importantly, you cannot allow your most precious resource to be consumed by pointless twaddle that not only does not result in any immediate income but steals your ability to invest your attention toward pursuits that might have exponential outcomes.

Never before has it been easier to be consumed by pointless twaddle, and to mistake twaddle for actual information. The most obvious distractions today stem from our constant connectivity which, by default, is very permissive in allowing twaddle to enter into our lives. Incoming phone calls and texts are classic disrupters of the state of flow and require constant context shifting in which deep thinking is impossible. Nearly every app one installs on a smart phone will send notifications and other interruptions unless we explicitly turn them off. Smart watches and smart speakers are even more intrusive than phones.

Yes, we can turn off many sources of twaddle, but do we want to? If we are going to be honest with ourselves, the truth is that many of us not only enjoy distractions but actively seek out twaddle as often as possible. Twitter is an excellent example of a source of noise that many people actively seek out, compulsively, multiple times every hour. The signal-to-noise ratio on Twitter, particularly on what is known as “fintwit”, is abysmally low unless one carefully limits followed accounts. Even then, what you’re mostly engaged in is the modern day equivalent of water cooler talk. Sure, it is entertaining, there are many links to worthwhile articles, you can communicate with some very smart and interesting people, and sometimes you might get an actual idea, but it’s hard to see most of it as much more than twaddle.

The concept of selling yourself your best hour can begin to counteract the malign effects of being subjected to noise. That “best hour” will naturally vary from person to person. If, like Charlie Munger, you find that your most productive time of day is in the early morning, don’t waste that time reading the newspaper, checking your Twitter feed, or even doing paid work for others. Instead, reserve that time to pursue projects that will add long term value and have the potential to produce exponential gains in your professional and financial life. Ruthlessly eliminate sources of potential noise during this most important hour by not being in the presence of your phone and making yourself totally unavailable to others.

There is much that we can learn from Charlie Munger’s latticework of mental models as well as the psychological framework he created entirely through self-study, observation of human nature, and practical application over a long lifetime. One of the purposes of Mr. Munger’s study of psychology was the realization that understanding irrational and harmful behavior and then doing your best to avoid such behavior can provide an enormous advantage in life.

Over time, dysfunctional behavior will change with technological innovation but human nature will change very slowly, if at all. The internet and connectivity in general has exponentially increased the amount of twaddle we are subjected to. But by creating so many productivity penalties that most people enthusiastically accept, it has also increased the dividends that will accrue to those who can resist the distractions that consume others.

Note to readers: This article is part of a series on Charlie Munger’s Psychology of Human Misjudgment.


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