TIP554: Mental Models for Successful Investing w/ John Jennings

You're listening to TIP. On today's episode, I'm joined by John Jennings. John is the president and chief strategist of St. Louis Trust and Family Office, which has over $12 billion in assets under management. I brought John onto the show to chat about his new book, The Uncertainty Solution. In this episode, we cover why humans are hardwired to shy away from uncertainty, mental models we can use to invest more intelligently, why we're hardwired to quickly come to conclusions, and tend to confuse correlation with causation, how the improbable is much more probable than we might expect, why the economy is not directly correlated with the stock market, where investing falls on Michael Mobison's skill-versaluck continuum, and much more. John brings a wealth of knowledge to this conversation as he is very experienced in the investment industry. Without further delay, I hope you enjoy today's episode with John Jennings. Welcome to the Investors Podcast. I'm your host, Clay Fink. Thanks a lot for joining me and congrats on the new book. The Uncertainty Solution. I'm going to talk about the Uncertainty Solution Solution Solution. What's fascinating is that uncertainty, or our quest for certainty to resolve uncertainty, is what's known as a primary human motive. We may not even understand that a lot of our actions and what we do really underpinning is the fact that we don't like uncertainty. It makes sense from an evolutionary standpoint. If you think back, if you were a human living in 10,000 or 100,000 years ago, your ability to recognize patterns gave you a survival advantage. If you recognize a pattern and then the pattern persists, it allows you to see into the future, which is a huge survival advantage. If you can recognize the patterns of, say, migration of prey, or weather patterns, or those berries or mushrooms, or nutritious or poisonous, all sorts of patterns give you a survival advantage. The way we've evolved is that when we can see a pattern, we feel good about things. When we can't recognize a pattern, which is really the very definition of uncertainty, we become antsy, we become anxious, we worry. In some instances, we can trigger our fight-or-flight response. There's things that we do in response to uncertainty that we may not even realize are going on. Once we resolve uncertainty, everything reverses. Instead of the fight-or-flight response, our parasympathetic nervous system kicks in, it's the relaxation response, we calm down, and importantly, we get a little dose of dopamine, which is pleasurable. It feels good. Really, our relationship with uncertainty is not just straightforward like, oh, we always dislike uncertainty. We actually like a bit because we love how it feels when we resolve it. That's why often we'll not want to know the ending of a novel or a movie. It's why some people like to gamble. It's because they crave the let's create some non-threatening uncertainty and let's ride that wave of adrenaline and stress and then feel fantastic when it's resolved. You tell this case study where people will turn over rocks and sometimes they'll get shocked, sometimes they won't, and it ties into the idea of humans not liking uncertainty where those who experience the most stress were those who couldn't recognize that pattern that you're referencing. If I were to tie that into my own life, I think about the example of going to a doctor and going to a dentist. If I go to a doctor to get a flu shot, I know that sharp pain is coming in my arm, but I'm expecting it. I recognize the pattern. I know it's coming, but if I go to the dentist and it's like, okay, I don't know if this is really going to hurt or not, I don't know which tooth is going to hurt on, and it's almost like psychologically agonizing that uncertainty that you mentioned and you discuss in your book. Yeah, absolutely. That study is pretty interesting and really what it found is as the study volunteers and how fun it shocked people. This was a video game they played and if they turned over a virtual rock and there was a virtual snake, they got shocked. They played around with, could they see a pattern to avoid the shocks? They see no pattern, so they got shocked about 50% of the time randomly and then there was a pattern which was they're just going to be shocked every time. That was actually a stress situation similar to being able to avoid the shock. It went like this, pattern, no pain, low stress, no pattern, 50% pain, high stress, pattern, 100% pain, low stress. Pretty interesting stuff. If you, to your point, exactly, if you think about it, if you knew you were going to be shocked, you would just steal yourself against it. But if you didn't know, so my parents have horses and they have this electric fence. So it's really just like a wire going around acres. And I remember once a decade ago, my dad was like, I don't know if the fence is on. Will you touch it and see if it's on? And again, it would be like a pretty big shock and I was like, no, there's absolutely no way I'm going to touch this fence because I don't know. And he kind of goaded me into it and made me feel wimpy. So I did. And I remember just like just the adrenaline rush, I can still feel it just thinking about, am I going to get shocked or not? Just the uncertainty was just terrifying. Your book lays out many mental models, as you mentioned, which we're going to be discussing during this episode. Charlie Munger is practically famous for stating that his key to success in investing in life is his ability to develop a lot of work of mental models. To open up this piece of the discussion, maybe we could start by just simply defining what a mental model is and explain why having a lattice work as Munger describes is helpful. Yeah. So he talked about this, you know, the first record I could find of it was back in 1994 to speech to the USC Business School. And really what a mental model is is it's just a model we keep in our heads, but it's how the world really works in particular instances. And you know, in reading about quite a bit in books on mental models, you know, what you come to realize is we all have mental models on our heads. But unless you spend time and effort to put correct ones in, you can have things that aren't true or you, you know, will jump to things just emotion and make bad decisions without having the appropriate mental models in it. And it takes study, right? So it's not like, oh, I can just read of something once and there it is. But you know, one that I love, and this is one that Charlie Munger has mentioned is Hanlon's Razor. So this is a great example. And, you know, if you've ever sent an email and not gotten a response, you often feel a little irritated or maybe even hurt, maybe even angry. But that's a great time to apply what's known as Hanlon's Razor, which is never attribute malice to that which can adequately be explained by stupidity or, you know, carelessness, law, this organization want to have you. And the theory behind this is, is that humans don't really have, for the most part, malice in their hearts towards other people. You know, if you don't get an email return, you get ghosted for a lunch meeting or your brother forgets your birthday or cut off in traffic, what have you, I think it's great to apply this and go, you know, I'm just going to give this person, you know, the benefit of the doubt. So that's an example of a mental model. And since I learned of this mental model probably 15 years ago, I use it all the time and it really, you know, saves my own emotions, it saves relationships. I hope people use it with me. I'm not actually that great of an email responder. So that's an example of a mental model. And what I found as I was researching, you know, how to become a better investor, really to help me and my colleagues become better advisors and then to help our clients be better consumers of investment advice. I found that really what great investors do is they have a lattice work of mental models. They have these things that they fall back on that are true and they know which ones to pull out when. And I know a few weeks ago on your podcast, you guys had Howard Marks on the show and he's like, he's an example of someone, you know, with his memos and his books and just like, you just hear him and he has these mental models that he falls back on. Like, for instance, I heard him at a conference back in October of 2022 and people were asking him like, what's your opinion of the future? And he was like, this is such a great mental model. He's like, okay, you can't really predict the future and those that predict the future don't do a very good job. But that doesn't mean you can't have an opinion. It just, it means that when you have an opinion, you should realize with humility that you're probably not right and wait that accordingly. He goes, so with that, I'm going to tell you what I think is coming. And I realize that there's probably a less than 50, 50 chance I'm correct. And at Oaktree, when we invest, we have opinions, but we also build in other scenarios and other things that could happen. And we don't go all in and like, wow, that is really a great way to think about it. Like you can have an opinion, but don't go all in. Now given that we have these issues with uncertainty and we have these mental models we can apply, what are some of the best ways we can deal with uncertainty when our instincts are maybe at times even almost forcing us to do something that might be really silly? Yeah, I think the first step and probably the most important thing is to learn to recognize when you're feeling uncertain and that you are really flailing around looking for certainty. Because again, it's something that most people aren't aware of. And even whether you're aware of it or not, this quest for certainty is going to drive so much of your behavior, even if you don't realize it. So if you can just like turn the light on to the fact that you're feeling uncertain and then just own it. So what I say to myself is, so I have this like alternate name for takeout and just because I didn't feel like John totally captures the essence of who I am. So this alternate name of Kiefer. And so what I do is I say to myself, when I'm feeling uncertain, I say, Kiefer, you are feeling uncertain. And that's the first and the key step. Like if you can do that, like you're most of the way there. And then to recognize here are the things that people usually do when they're feeling uncertain. And then what should I be doing instead? It reminds me of when there's stock market volatility. People will do something they think is good because it gives them more of a certain outcome. For example, maybe they sell after a stock market drawdown. They're tired of the uncertainty of what sort of volatility is going to come in the future. And they just want the certainty of being in cash, no more volatility. And they think it feels good to do that. And they think they're making the right decision, but they're actually making a poor decision because they're acting based on their primal emotions. Exactly. That is spot on. Yeah. And what we usually do when faced with uncertainty, there's a lot of different things, but there's four big ones. And the first one is we have this what's known as the need for cognitive closure. So when we feel uncertain, what we do is we become hyper vigilant where we look for answers. And what we want is we want an explanation. We want the world to make sense. So we tend to do what's known as seizing and freezing. So we seize on the first explanation that hits our worldview. And then we freeze on it. So we don't want to revisit that uncertainty in the future. So we defend it. So you have this situation of you have this probably not super wealth thought out or researched response of seizing an explanation. And then we freeze on it. Like that's it. And I think COVID, the pandemic was this great example of that for so many people, myself included, which is we didn't know what was happening. So we would seize on explanations for what was happening. And then we would stick with it, even if the science had changed or the virus had changed. And so we tend to grasp these explanations and no, no, tend to change our minds or our worldview. So that's the seizing and then the freezing. Another thing we do is we become information junkies. And I've done this when there's economic uncertainty. I definitely did this and COVID-19 was first flaring out is we also get a hit of dopamine when we take in information. And when things are uncertain, and what we want to do is we want to find answers. And especially with the internet and social media and everything, it's more easy than any other time in human history to search for answers and to search for clues. And that can be great. So if you have something that is unknown that can become known, searching for more information is great. But if you have something that's just unknowable, flailing around searching for information isn't productive and can actually be counterproductive, you may think that you've come up with answers when there's no real answer. And a great example of this and another thing we do when we're faced with uncertainty is we turn to experts for their predictions of the future. And experts definitely can predict the future in areas like engineering and medicine and these other things. But when you have things like the stock market and the economy or even geopolitics, the ability of experts to predict the future is just really they have a real poor track record. But we find ourselves, in fact, I have to resist it, clicking on these articles where some famous guru is telling us what's going to happen in the future. And again, we feel like we've got a dose of certainty when you have somebody that's a confident expert that tells you what's going to happen in the future. And one of the final things we do is we like to associate with groups that think like we do. And in doing research for this book, I came across this comment by a sociologist, which I think is spot on and is one of the biggest things that has shifted my worldview of how people can have such differing views and what the truth or facts or reality is. And that is the truth is whatever your social group believes it to be. So whether it's politics or the economy or religion or all these other things, whatever your social group thinks the truth is, is what you think the truth is. It's like, wow. So when we feel uncertain, that's not a time period where we want to go and debate or hear from people, all these differing points of view from our own. We tend to insulate ourselves in these echo chambers of people that think like we do. So that's what we tend to do when we are feeling uncertain is, you know, season freeze, we seek more information, listen to experts, we surround ourselves with people who feel like we do. And again, most of those things are either not productive or even counterproductive, just things that we all should be able to look out for what we're doing in the face of uncertainty, which really doesn't bear fruit. The last of the four you mentioned there really hits home for me where people fall into their camp and they fall into the echo chamber, especially with things like social media and falling prey to listening to just specific experts. One of my biggest insights from tuning into William Green's episodes here on The Richard Weiser Happier Show is that, you know, he mentions it time and time again, is that the world is fundamentally uncertain. And when people fall into these camps, they can become extremely overconfident in what they believe in. And they just continually tune in to this one opinion. And I think it's so empowering to just understand that, you know, there is a possibility that we're wrong and there's a possibility that maybe the world isn't the way we believe it to be. And we need to position ourselves to account for that uncertainty. And it also ties into that point of Howard Marks earlier that you mentioned. Yeah, exactly. And we get to the point where we surround ourselves with people who think the same and we consume the same media and the same social media. And it seems like it's not possible that other people think something different. That ties into the next question I wanted to ask you, which is related to people quickly coming to conclusions because, you know, they just see this simple piece of data. They're like, of course, then if this happens, then this is going to happen after that. And you caution in your books that correlation does not necessarily equal causation and that the world is a complex adaptive system with many different variables that really can't be analyzed in isolation. And you tell this different example in your book of a child's academic achievement, how that turns out in the number of books that the child's parents owns in the household. And it makes sense that, you know, a child, if they're surrounded by parents that have a lot of books, then they're probably more likely to, you know, have better academic performance. But that's not the only variable at play. There's people with more books in their household might just generally read more. They might do other things. They might, you know, push for higher education, things like that. Can you expand on this idea that because humans don't like uncertainty, we're prone to quickly jumping to conclusions that are either too simplified or maybe not even true? So yeah, I have an entire chapter in my book called looking for causes in all the wrong places. So it's all about causation and correlation and full of stories and examples. And the one you mentioned on books and educational attainment looked at, you know, the number of books in a home and educational outcomes over 27 different countries. And this study was popularized in the book Freakonomics. And it's really the point of what, you know, the Stephen Lovett and Stephen Dubner said in Freakonomics is they dug into this was really the answer is that there's this common cause of, you know, of educational success is the result. The books, having the books in the home didn't cause that. It was a symptom of the sort of parents that they were, right? Both their genetics and, you know, their view of learning. You know, the type of person that buys a lot of books was correlated with higher educational outcome. Their children having a higher education, educational outcome. So it was like this common cause, right? You know, smart educated people buy more books, smart educated people tend to have children that go on and achieve a higher educational success. So that was that, that example there. And there's all these other, there's all these other things with causation. And again, it comes back to our dislike of uncertainty. Like we want the world to make sense and we want to have a cause or an explanation. And sometimes it's difficult. And, you know, another, another story I told the book, which was really quite humbling, is I was at this investment conference, you know, years ago, probably, you know, it's probably five years ago. And you know how these investment conferences go? Like you have all day of like talks and everything and then you have like a cocktail hour and then dinner. So, you know, as I'm sipping my, you know, probably $12 bottle glass of wine. I was talking to this woman who's the CEO of an investment firm. And it was pretty news. It was only around for three or four years. And I was like, so what does your firm do? And she said, oh, what we do is very simple. We only invest in companies that have strong female leadership, either, you know, female CEO or president or females on the board. And it's because, you know, female led companies outperform male dominated ones. And it's like, wow, that is amazing. So I instantly was thinking like, that makes total sense, right? Like, and I dug into the research when I got back to work. And, you know, there was all this research that supported the fact that female led companies outperform. And it's things like women are more risk adverse. So, you know, their companies won't maybe have the same propensity to blow up. You know, women consumers make 70% of the buying choices. So maybe either more in tune with their fellow females, you know, more diverse teams outperform. There's, you know, female leadership style. Stereotypically is more nurturing. And then if you've made it to, you know, president or CEO or the board of directors of a company and you're a female because of the glass ceiling, you're probably totally a rock star. So maybe these female led companies have stronger leaders because they've had to run this, this goal is like, this is amazing. So, you know, not long after this conference and looking at this research, I was meeting with a client of mine, who's one of the smartest people I know. And he led this fortune 100 company as CEO. And I was telling them about this investment firm. It's like, it's pretty interesting. We're looking into it as an investment. And he's like, yeah, but is there really a causal link? Like, where is that causal link? Are you sure that there's not like a common cause or like, is this a symptom? So I was like, oh my gosh, maybe he's right. Like my first reaction was to dig in and defend. But like I have so much respect for him. Like I think if most other people would have questioned me, I'm like, no, no, no, I've researched this. This is, this is good. But I decided to do something that's really hard in battling something is known as confirmation bias is I was like, now I'm going to go try to find studies that disprove this. And I found ones that took the other side. And really to summarize those, it basically said that when you have a company that's doing really well, highly successful company, that they have more resources to spend on things like diversity. And there was this, the psychologist that had dug into this that said, you know, it's almost like a cynical measure by like company saying we're going to recycle our annual reports, you know, or, you know, we're going to, you know, buy carbon credits, you know, as almost PR that maybe high performing firms are more likely to hire female leaders and female board members. And there isn't, you know, the jury's still out. What hasn't been done so far, at least as of about two years ago when I last researched this, there haven't been longitudinal studies between companies to really tease this out. So I'm not saying that, you know, strong female leadership isn't a cause of high performance. In fact, our company, I'm president of our company, but our CEO is a woman who's incredible. You know, we're, we have 70% female employees here. So I'm a big fan of female leadership and female lead firms. But you know, the jury is out and you know, I had kind of jumped to this causation explanation. And my client's point was a great one. You know, maybe it's a symptom instead of a cause. And you know, I go through a lot of those things in this like that in the chapter, which is really, you know, teasing apart how to, how to look at things and to say, is this just merely correlated instead of caused, you know, is it a common cause is the observation effect, understanding that there's often multiple causes. It's hard to pin down, you know, a linear, you know, relationship. Yeah. So I think it's an interesting area and one that's absolutely essential to understand as an investor. Let's take a quick break here from today's sponsors. Are you curious how equity crowdfunding provides unique access to investment opportunities that are typically reserved for venture capitalists and private equity firms? Recently, I had the pleasure of speaking with Auto, comma co-founder and CEO, Daniel H. Glancy about the evolution of capital formation and the rules that have evolved over time, allowing enterprises to challenge traditional capital raise norms through equity crowdfunding. During episode 541, how equity crowdfunding is changing the game, Daniel and I discussed the role equity crowdfunding plays in this tumultuous economic environment and its benefits for everyday investors. In fact, Auto, comma has opened its own successful equity crowdfunding round and time is limited to get in on this exciting offer. Join me and thousands of others that have made an investment in Auto, comma by learning more at invest.auticomma.com slash wsb. That is invest.auticomma.com.com slash wsb. Are you looking for an easy way to build wealth and go beyond stocks and bonds? Equity Multiple brings you streamlined real estate investing starting with just $5,000. Equity Multiple makes it easy to invest in real estate. All it takes is just a few minutes and you're able to select from curated investments that fit your personal strategy. Since 2015, thousands of investors have discovered better real estate investing through equity multiple as they've delivered a 17% total net return to investors over that time. And if you sign up at equity multiple dot com slash wsb, you can earn a return boost on your first investment. Be sure to sign up at equity multiple dot com slash wsb. Equity Multiple Welcome to modern real estate investing. Past performance does not guarantee future results. Please visit equity multiple dot com for full disclosures. Hey guys, so we all have a basic understanding of how IRAs work. You save a portion of your income, invest it in the stock market, and then cross your fingers it grows enough to retire on. So how do investors like Peter Thiel have Roth IRAs worth billions? Well the investment secret is something called a self-directed IRA, which has all the tax advantages we love but with a twist. Instead of being stuck with stocks, bonds, and cookie cutter options, a self-directed IRA with new direction trust company allows you to invest your retirement savings in what you know and you're passionate about. From private equity and startups to precious metals and loan financing, there are nearly unlimited investment options. You could even buy a rental property and collect rental income back into your IRA. You name it, NDTCO will help you fund it. We're not saying you'll be the next Peter Thiel, but we're not not saying that either. Because his secrets are now your secrets. Check out new direction trust company and self-directed IRAs today at NDTCO.com and unlock the potential of your retirement savings. Alright back to the show. You tell another story in your book of how you were on vacation in another country and you were out for dinner with your wife and you ran into an old friend at a restaurant thinking that how could this happen? This is just so improbable that it practically felt like a miracle to you that fate put you at the same restaurant in this different country in the same city. How big the world is? It just seems like it's totally impossible. But then you make the case in your book that highly improbable scenarios are actually to be expected. So I'd love for you to dive into this and talk about how the improbable can seemingly happen all the time. Yeah, and it's kind of like this topic is in some respects kind of a bummer, right? Because like we all love a good coincidence and you know it's great to look at a coincidence and think okay this shows that there's like this you know that there's more meaning to the world, right? Like there's this underlying you know ebb and flow that maybe we don't understand as humans and you know life does have meaning or what have you. So when I have given talks on this topic people have been like wow that was really about skill. We were in Paris and we get seated at our table and you know one table over is this like fraternity brother of mine. I hadn't seen him in years and his name's Dave and Dave was like oh my gosh this is crazy like how improbable is this. And one way to look at it is and I first thought oh yeah like what are the chances like one in a hundred million like this is insane but really the way to look at it is not the way that I initially looked at or Dave looked at it which is like wow the universe is telling us something you know maybe we should reconnect and become friends again right you know that fate sings on me but really to step back the way to analyze this is to say what are the chances that in all my travels that I would be see somebody you know whether you know in a movie theater or on a bus in a museum see the next dinner that I knew from the thousands of people that I've known during my life and you know it's still a coincidence and it's still fun but it's not one in a hundred million it's more like okay over the course of decades it's almost certain that this sort of thing will happen and there's something you know a way to think about this there's something called Little Woods Law of Miracles and what this mathematician did is he said okay how often do we experience what you would consider a miracle like me being seated next to a fraternity brother you know in a restaurant in Paris and he said you know let's define a miracle as a one in a million occurrence and then he calculated how many occurrences do we have a day and he came up with about a thousand I guess 30,000 things that you observe and see you know during a day and so if you do that and you multiply it by the number days in a month you come up with you're going to hit one of these one in a million things about once a month and even if you say well 30,000 a day is too high maybe it's you know 20,000 or 10,000 or 5,000 a day you still come up with the fact that you know many times a year you're going to have just absolutely extraordinary coincidences that are just amazing and you know Richard Feynman who is a Nobel Prize winning physicist and just an all-around entertaining guy you know unfortunately he's he's not alive anymore but he has this book that he wrote that's kind of memoirs called Shirley or Joaquin Mr. Feynman which is I highly recommend incredibly entertaining but one thing that he's known to say is you know here on the you know I'm going to paraphrase you know on the way to dinner tonight I saw something extraordinary a car with the license plate AEW357 isn't that amazing right and his point is is there's nothing special about that license plate it's just one of the 30,000 things that we see a day but you know if it had somehow been my initials and you know my you know my year of birth or something it would have been just like this extraordinary like oh my gosh the universe is talking to me you know occurrence so really the the mental model here is that the highly improbable happens all the time because there's this you know just huge tens of thousands of things that happen every month and if that's the case we need to train ourselves not to read too much in to patterns that we see that really aren't grounded in anything other than randomness and chance if I were to tie that into investing I would say that you want to always account for the improbable scenarios you know if you're ever considering doing something like using leverage or concentrating into one particular asset you should always account for the fact that no matter how certain you are on this particular strategy the always like you know do things like diversify and have excess cash to take a new account for those improbable type scenarios yeah the improbable scenarios happen all the time and yet we as humans and its human nature we seem surprised almost every time it happened if it's something like being seated next to somebody a dinner at a foreign city yeah that's just kind of fun but to your point sometimes these improbable things you know really can have an extreme effect on our actual lives and yet we end up being surprised by them I think one oversimplified assumption that people make that you talk about in your book is that if the economy is doing poorly or if people even think the economy is going to do poorly in the future then their stocks are going to go down or the stock market is again to perform well but you make this brilliant point that the stock market is not the economy which might be obvious to some people and maybe a surprise to others and you share this great Howard Marks quote that in investing there's nothing that always works since the environment is always changing and investors efforts to respond to the environment cause it to change further so why is it that the stock market is not necessarily directly correlated to what's happening in the economy yeah so I think this is probably from a pure straight up investment standpoint the most important mental model in the book and let me just touch a bit deeper on the stock markets not the economy and then we can maybe hit why that is but really what this says is that what's going on in the economy and what's going on the stock market are uncorrelated so if you look at current year GDP growth and current year stock market returns going back to World War II correlations 0.03 so basically 0 and what this means is there's years where the economy is roaring and the stock market is not doing well or even down and there's years where there's recessions the stock market is up so in fact looking back to the 1930s of you know the 19 years where there's actually been negative GDP growth in a year in other words during a calendar year you know 12 of those 19 years the stock market was up and most of the time more than 18 percent and so you can look at that go well that's bonkers like how is it that you have a contracting economy and a stock market this up but what's fascinating and this came out of research I read that came from Credit Suisse I'll just say that name because that name is going away as they're being you know subsumed by UBS you know I think here in the next few months but really if you look at the prior your stock market returns in the current year GDP then the correlation jumps to you know kind of a 0.6 and above meaning that the stock market predicts what the economy is going to do not perfectly kind of an ish right but the economy doesn't predict what the stock market is going to do and as an investor you'd love to have it reversed you'd love to say because it's easier to kind of figure out I mean not you know ish what's going on in the economy and say okay I'm going to use that to inform my investing so you could say oh you know I think inflation is a problem and interest rates federated interest rates going to slow the economy and therefore you know we may not tip into recession but we're definitely going to have slower growth here for a while right and then if you you could take that and say now I'm going to use that to kind of time my investments that would be amazing right but that's not how it works so the stock market moves in advance of the economy typically up and down and tells you what the economy is going to do which is a has some usefulness but as an investor it's just not it's just not very useful and so what that means is is pretty much every economic indicator out there doesn't tell you what's going to happen in the stock market and I'm I've been on a number of like charitable investment committees over the years and even chair of you know some endowments and we'll have these investment managers or these consultants come in and they'll give us their economic update and they'll talk about all these things going on in the economy their views of you know the path of interest rates and inflation and unemployment claims and GDP growth and corporate earnings and all these things and then based on that they'll talk about how they would tweak the portfolio and you know what they're missing out there and I'll talk to some of them and I'll say you know do you realize that all those things you just listed out don't tell you what's going to happen with stock market returns and some of them are surprised by this the more erudite ones go well we know and I'm like well then why did you spend you know half hour talking about them but it means that all these economic indicators don't tell you what the stock market's going to do which is again it's it may seem like depressing and like oh well that's telling us there's no Santa Claus but knowing that is so important so like during covid when things were getting really bad you know we didn't go to our clients and say you know let's take some risk off the table and move out of the market in fact if anything we rebalanced into stocks not thinking that we knew when the bottom was we just knew that all the bad news in the real world and in the economy wasn't going to tell us when the stock market was going to bottom or what the stock market was going to do so you know that it was you know kind of this incredibly short bear market that was very steep and then this great rebound and I think people that looked at all the bad news they missed it they didn't invest their money or they pulled money out and you know the bottom was March 23rd of March and on that day or like three days later they announced the thousandth covid death in America I mean imagine like if somebody you know think about this claim somebody said hey guess what I have a crystal ball and here's what I'm going to tell you okay we just hit a thousand deaths we're going to have nearly you know 350 thousand in the u.s. by the end of the year it's going to hit a million or two million worldwide international travel is going to shut down and support pro sports leagues are going to stop and all these restaurants are going to fail entire industries are going to be decimated you know gdb growth is this quarter is going to be a negative 14 something percent unemployment is going to spike to nearly 15 percent here in a week or two we're going to have three million weekly unemployment claims like if we knew all that and oh by the way this is going to go on for years like if we knew all that like we would be like okay we're taking our money out of the market but if you use the stock market is not the economy you know that you can't use what's going on or even if you knew what was going on the economy you can't use that to inform what's going on in the stock market in fact I wrote an article in Forbes on March 26 three days after the bottom that said even with a recession looming that doesn't mean you should sell the stock market and I went through a lot of these things and I had people say wow how did you know how did you call the bottom and they're missing the point like I didn't call the bottom I had no idea the point of the article is we have no idea could have gotten worse absolutely why was that the bottom don't know exactly so I think that's what's important to know about this middle model the stock market's not the economy and if we moved it like why is that the case and that's where we get into this concept of complex adaptive systems and you know this really comes from engineering but it is applicable to complex social interactions so this is true of politics is true the economy it's true of the the stock market and the idea here is that in the economy and you know in the stock market you have actors that are intelligence called agent so these are all the people and all the companies that buy and sell stocks so they're intelligent so they don't operate on rules of physics you know like Newtonian physics or even the theory of relativity right it's everybody watching each other watch everybody watch everybody else so we're all trying to decide what everybody's doing and if you think about investing the true value of a company is what the market says it is which means everybody else and we learn from patterns so we have these feedback loops we have external information so you can use like for example let's use like GameStop so you know going back to the the meme stock you know from early 2021 and you know really there was no underlying sound fundamental like economic reason why GameStop would do well really it was you know this chat group on on reddit that started driving it up and so people bought shares a GameStop because they thought other people would buy shares a GameStop and you know it was AMC as well and you know bad path and beyond which just declared bankrupts you know unfortunately but then what this did is this caused real world effects so like what AMC did which was brilliant is they said hey like if these Reddit people are going to push up the value of our stock we're going to issue more stock we're going to gain all this like finance actual financial footing so they started issuing shares a stock which in turn you know gave the company more money to write out you know the problems with movie theaters and everything so it created these real world effects which in turn made people go oh well maybe we should buy AMC it was fascinating that this sort of thing happened but what it means is with a complex adaptive system is you can't take the inputs and know what the outputs are going to be it's like toilet paper hoarding in the pandemic like going to the pandemic like clay if i was like what do you think if you know people are going to hoard some stuff what's it going to be like if you're like me i would have said jugs of water cans of beans or i don't know something useful to survival you know not toilet paper but once it happened individual rational actions which is if you see some toilet paper buy it like don't let that package of toilet paper pass you buy because you don't know how long this is going to go on but that further created this action this irrational outcome system wide which is a toilet paper shortage which was bonkers and you know i was part of this in april 2020 i was in walgreens picking up a prescription and i saw you know this mostly empty shelf of toilet paper and there was one package there and i bought it even though we didn't need it and i was telling the checkout clerk i'm so sorry i'm buying this we have plenty of toilet paper i'm being part of the problem not part of the solution and you know she was looking at me and like just i have no idea what you're talking about just check out so that's really how the stock market economy work is you know all these individual actors that are intelligent and learning and and reacting to patterns and that's why it's so hard to predict you know what's going to happen in the stock market or or in the economy this is why experts get it wrong over and over again because it's just not something that can be modeled well and it's why you know patterns that have persisted in the stock market in the past won't necessarily work in the future but it's because you know we've learned from the prior patterns and once a prior pattern is known then everybody knows it and you have to have a buyer for every seller and a seller for every buyer right so anyway i've probably been just uh getting too excited about these two mental models i wanted to tap more into the great financial crisis i didn't personally experience the dot-com bus or the great financial crisis as an investor myself so it's always interesting to draw from the experience of others who actually lived through it and i took this piece from your book that the market bottomed on march ninth 2009 after a 57 drop and the trophy the recession in economic growth didn't come until four months later in june and you know just ties directly into since the economy is not the stock market you know just because the economy is going down the stock market actually rebounded four months before the economy rebounded and i'd love for you to tell the story of the hedge fund manager you chatted with during that time and you chatter with them and he was just screaming more pain to come and you actually decided not to make any changes to your client's portfolio so i'd love for you to tell this story so first of all let me say that like the great financial crisis the great recession wow like it's one of the really seminal things you know experiences i've had in my life it was so stressful like i felt all this responsibility for our client's assets and i really you know i hadn't developed all these mental models and i didn't know what to do and i i was this big consumer of financial information like i my amount of knowledge about what's going on in the economy in the markets was greater than it is now but i what i was lacking is you know kind of the the charlie monger wisdom mental models to make good decisions and so it was really the great financial crisis that was the impetus for me writing this book is all that i've learned because i realized after that experience that i wanted to find you know what did great investors do what do they know that i could learn that that really spurred me on the the financial crisis you know and what i was doing is trying to find more information about like i couldn't see how we were going to get out of this and i know that the entire global financial system almost collapsed i don't even know what that means i just know it's really bad and i was reading all these economists and bestment managers that were just saying you know there's no way out and everything's going to get worse and so i'd gone to a conference the prior year where i had met this hedge fund manager that had given a talk and he was so impressive and their returns were great you know kind of back in the aughts you know hedge funds were kind of the darlin investment and money was flowing into home and this guy was so impressive had all these pedigree and everything and i ended up you know having an adult beverage with him in the cocktail hour of the investment conference a way to exchange cards so i'll call him tom as i do in the book it's not as real name but you know i ended up emailing him and setting up a time to talk and you know it was on the phone you know back in 09 we didn't like you know zoom and you know sky and i asked him i was like you know what do you see happening what's our way out of this and he said oh you know what we've experienced so far is just an appetizer to like this much bigger meal of misery that we're gonna we're gonna have and he says they'd moved their hedge fund mostly to cash and gold and you know it's like a three billion dollar hedge fund you know they they'd they'd moved it almost out and you know they were pretty sure that the stock market which was at this point down you know nearly 50 percent in february of 09 was going to be down another 50 percent you know the way that math would work i guess that'd be like 75 you know over 75 percent down from the the high and he was at the time just so incredibly dower and he had all these great reasons and there were things that i'd read before but to read someone that had actually said okay we're you know really selling our clients out and he said he had even bought farmland in new jersey because he lived in New York City and he had like this stockpile of gold coins to buy passage out of New York City if which he thought was a decent chance if the you know the economy collapsed he was like it's going to be like you know escape from New York stuff if you know the old movie by the way which was filmed in st. Louis go figure but you know the old movie escape from New York he was just like i'm going to be able to get by passage out of New York City and you know maybe gold has always been a store of value for most of civilization and you know they had like guns and generators and seeds and everything and he was going to like live off the land and like rural New Jersey and i was like oh my gosh like i am so upset you know and i remember talking to a few of my co-workers and fortunately you know they kind of talked me off the ledge you know and i did like breathing exercises and meditated and they're just like okay it's just one opinion i'm like yeah but there's a lot of people with similar opinions but i think cooler heads prevail because it really really freaked me out you know and but i look back on that in addition to being an entertaining story in russ respect and by the way what what he predicted could have happened like it could have happened it just didn't and you know later in my book i talk about something called invisible histories which are things that could have happened but didn't so i i look back not just to be like you know and i say something's funny in my book like whenever i look you know think back on the story i think about tom sitting in a seller in new jersey you know like with a shotgun across his lap you know eating a can of peaches right or something you know which i thought was kind of funny but i really have more sympathy for this you know and you're in if you're a hedge fund manager you know maybe you're all about making big calls and he could have been correct but i use this as a mental model to remember that you know even if you have all the possible information you can have your uh you know this highly pedagreed you know hedge fund manager with all this staff and this analyst analysis and research it doesn't mean that you're going to be any better than anybody else from calling what's going to happen in the stock market and about a month later is when the market bottomed and his hedge fund and i haven't gone back and checked it out but they may well have gone out of business because they had moved everybody to cash in gold and missed the you know from from march 9th 2009 you know the end of 2022 even with 2022's down period stock market's been up over 600 percent so yeah that was a costly mistake and just it reminds you that you know even though he could have been right this idea that you need to know what's going to happen in the future and you should follow expert prediction so invest it's just a great example of why none of us should invest based on our own or others predictions of the future i think this ties well into a point you make from your favorite investment book which is the success equation by michael mobison who has been on the show back in 2021 i believe in it he has what he calls the skill luck continuum where certain activities fall somewhere on the spectrum of primarily being skill-based or primarily being luck-based based on your research and writing this book where do you think investing falls on this spectrum yeah and of his books you know the success equation and it's really my favorite investment book because it's it's had you know this outsides maybe the biggest impact on how i imbue the you know the investment world and really opened my eyes to a lot of a lot of things and yeah his skill luck continuum is pretty fun because it's not just investing you know you know in one end of the the pure luck is you know like roulette and slot machines you could put the lottery there you know just complete luck and at the other end things that are 100 skill like chess is 100 skill and things that are pretty close to full skill which are like races so like a running race like a hundred meter race running race or you know in swimming so if you think about it like michael felts you know he's going to be a less skilled competitor pretty much every time there's very little luck involved i guess he could like you know slip a little bit coming off the block or have a something happen but really i guess you know that even that falls within skill but then you look at a lot of sports and you know they vary and and how much you know luck is involved you know i love i love hockey and all the time you know you'll watch your your team and your team will hit the goal post a few times and you know you'll lose or you know the vice versa happens or you know you're watching football in a you know the game winning field goal doings off the uprights or there's all sorts of things that happen that that you can see where you know luck comes into play but really you know he did all this the study and research and analysis and what he found is investing falls way down towards the luck into the continuum you know skill matters but it it's way you know it's it's it's definitely much more towards gambling in some game like poker you know has a lot of skill but it's much more down towards you know the roulette than it is up towards you know chess or swim races and he asked a few great questions that we all can ask to tell where an activity falls in the continuum and the first is can an amateur beat a pro and the answer on skill based things is no like i don't play chess so if i if i played my nephew who is this incredible chess player like i'd have zero chance of beating him and you know i swim and if i swam against michael phallop's like it would be laughable like orana running race against like a college you know or even high school you know track person that they would just they would cream me and you know same thing like like one-on-one basketball or horse against like a college basketball player like all those things like an amateur cannot be the pro whereas if you think about roulette like can an amateur roulette player be the pro roulette player yeah of course like it's it's random right and or slot machine like can an amateur slot machine player win and if you think about investing an amateur can be to pro all the time and i tell the story of my book of in 2020 our highest performing portfolio in 2020 was out of a middle school you know we had helped her and set up an account at schwaub and you know educating her on stocks and like oh what stocks would you like to buy you know i think she had like thousand bucks for grandparents and you know she picked like netflix and tesla it was like some of the highest performing stocks of 2020 so it was like three or four stocks and you know we went back and looked at like you know what can we learn about the high versus low performing portfolios and yeah so this middle schooler was the top performing and so it just shows you that an amateur can be to pro and investing and it happens all the time especially over shorter periods and then on the other question he asked which is so good is can you lose on purpose so if it's if the outcome is mainly based on skill you can lose on purpose so like i could you know my nephew in chess could choose to lose to me on purpose he could intentionally make poor moves or if i was swimming against somebody that was a better swimmer they could choose to swim slower and i would win or you know i raced my now six-year-old nephew and like i'm still faster than he is so i could choose as i usually do to lose every once in a while i choose to win but mostly i choose to lose right and the same thing's in investing true of stocks like can you lose on purpose and you know when i ask this question of people that they often say oh well yeah and this is though not really because if you could pick stocks in advance that weren't going to do well you could make a ton of money as a short biased you know stock bigger you could short stocks and they're basically you know like no famous short managers because it is so hard to do that in general stocks go up to so pick the ones that go down or even pick the ones that are relatively don't do as well as others is incredibly hard to do because you know long short hedge funds their history and their their performance hasn't been been great so it just really shows you that you know investing you know skill does matter but there's a huge component of luck and what this means is is when you see an investment manager or a middle schooler that does really really well you know it behooves us not to read too much into their performance or if they do really poorly we can't read too much in their performance i mean if picking a star investment manager that was going to outperform in the future was merely as simple as how they perform into the past and let's pile into the ones that have done well that would be easy but you know what studies of public stock managers have shown is there's basically no persistence from year to year to year and you know very few investment managers over long periods of time show that they have skill and they deliver out performance beyond their fees so there's a lot that have skill but just not in excess of their fees or especially you know the taxes that might be generated so what it means is is picking a manager someone that's going to you know buy stocks for you is going to outperform you know picking a manager like that is really hard because there's so much luck involved and it's so hard to tease out skill i think a key part of that last point with the difficulty of success in investing over long periods of time is that times are continually changing you know an investor might have a really good decade but if they apply that same exact strategy the next decade then odds are they aren't going to do as well because just times change and the environment changes yeah that is so true it's really hard and what happens is as an investment manager there's ways to invest that you have a high likelihood that you're going to beat the market but the problem with them is that it takes a lot of time for you to be correct and there'll be a lot of time where you look horrible and in fact vanguard did a study of investment managers that had over 15 year period that both survived and then beat the market and of the over 1500 funds they looked at you know only 18 percent actually beat the market over the the 15 year period and that's pretty consistent with other studies by S&P and others that have looked at you know the success of active managers but what was fascinating of the 18 percent two-thirds had five or more years of underperformance so five years out of 15 years if I do my math correctly is one third and a lot of them had six seven eight years of underperformance and also the majority of them had at least three years of consecutive underperformance and so what that means in the real world is if you're an investment manager and you're like okay i'm going to out perform but i know that i'm going to look like crap like a lot of the time the problem is your investors likely won't be sticky and that after three years of consecutive underperformance or four or five even or you know i'm underperforming five or six or seven out of 15 years you know you'll have people fire you and you will go out of business so what the investment managers do is they change their strategy so they don't get fired or they invest in a way that is very similar to what the market is and they just tweak it a bit so they don't look too different and it's really a business decision and it's really based on it's really based on the investor it's really the investors you know and you know there's this idea that if you could invest maybe with a manager that has a lock up so imagine if you invested with an investment manager that said i'm going to buy publicly traded stocks but you can't get out for 10 years or you could invest in a publicly traded manager that you can get out every day i'll tell you that the one that you can't get out of for 10 years likely with a high degree of likelihood will beat the one that you can get out of every day because the one that's investing for 10 years is going to invest with a long-term view and not be worried about whether their investors are going to pull out and they won't change their strategy and they'll stay with something that has been shown to you know likely over long periods of time beat the market. Let's take a quick break and hear from today's sponsors. Are you into real estate investing but don't really know where to start? Back in 2019 Robert Leonard started our millennial investing in real estate 101 podcast. The real estate 101 show today is hosted by Patrick Donley and he brings on some of the best and most relatable everyday investors who have real world success and experience in real estate investing. The great thing about real estate is that there's so many ways to benefit from it including house hacking, long distance rentals, Airbnb, storage units, commercial real estate, the list goes on and on. Although our real estate 101 podcast is a little bit less well-known relative to our other podcast it's actually been downloaded and played over 2 million times since inception. The show's most popular episodes are episode 85 with Alan Corey where he explains why he chose real estate as his path to achieving financial independence, an episode 88 with Tony Robinson covering Airbnb and short-term rental investing. Check out our real estate 101 show today by searching for millennial investing on your favorite podcast app and clicking follow. This episode is brought to you by AlphaSense, the AI platform behind the world's biggest decisions. Are you still leaving Alpha on the table? The right financial intelligence platform can make or break your quarter. AlphaSense is the number one rated financial research solution by G2. With AI search technology and a library of premium content you can stay ahead of key macroeconomic trends and accelerate your research efforts. AI capabilities like smart synonyms and sentiment analysis provide even deeper industry and company analysis. From when to buy, hold or sell investments to why, AlphaSense gives you the tools you need to provide better analysis for you and your clients. As a listener of We Study Billioners, visit alpha-sense.com slash FS today to beat FOMO and move faster than the market. That is alpha-sense.com slash FS. Did you know that cheese can be used as collateral for a loan? Don't worry, I had no idea either until I read our free daily newsletter. It covers financial topics like stocks, bonds, and mutual funds, but it also covers other interesting and unique markets like the cartel, Hollywood actors, how an oligopoly works, and even the cheese market. I love learning about financial markets as much as the next investing enthusiast, but the stories about other markets keep me on the edge of my seat. Each line makes me want to read the next one. How can Tom Cruise get paid $100 million for Top Gun? The movie still makes money. The acting in Hollywood markets are actually quite interesting. The best part is you can learn all of this for free in just 5 minutes a day. Join over 30,000 other readers now at theinvestorspodcast.com slash We Study Markets. Join now at theinvestors podcast dot com slash We Study Markets today. Alright, back to the show. You also touch on some behavioral biases in your book that are, again, hardwired into us, which essentially means we're all susceptible to these to some degree. And two very common behavioral biases are loss aversion and overconfidence. And part of me feels like these kind of go at odds with each other. If you're loss of verse, then you might not take enough risk. If you're overconfident, you might take too much risk. So I'm curious if you believe that most people are susceptible to both of these to some degree or do people sort of lean one way or the other that they should be aware of? Yeah, I don't really think that they're actually at odds. I think there are things that each of us applies at different times. And I'll give you an example. So if you're overconfident, so it means that you think you know more than you do, you're better than you are, you're better looking than you really are, you're a better driver than you are, better spouse parent on down the line. But in terms of investing, again, it means that we think that we know more than we do or that other people do that we make better decisions. And then we have this loss aversion, which at its core states that losses feel more painful than gains feel good. And so there's these different things that we do when we're faced with decisions with loss aversion. The first is is we make decisions to avoid losses. But then importantly, once we're at a loss, we tend to double down. Like we don't want to keep, we don't want to lock in the loss. And I think overconfidence there goes hand in hand because when you're down and you decide, okay, I'm going to double down or I'm going to engage in risk seeking behavior because I don't want to lock in a loss, it just shows right there that you're being overconfident in terms of your abilities. And really, you should step back and go, okay, this investment that I have is down. It's at a loss. What should that teach me about my ability to make investment decisions? If it's just the rest of the market's down fine, but if it's down more, if it's an individual stock or other type of investment, maybe you should say to yourself, I don't really know what I'm doing. And I'm going to cut my losses instead of engage in risk seeking behavior. But I do, to your point at the beginning of the question, I do think that these are two of the biggest behavioral biases to be aware of as investors. And I hit five of them in that chapter. And there's entire books and great ones written about behavioral biases. And I think a key takeaway is, and my business partner Spencer Burke, who also my mentor, what he has said over the decades is, you read these books about behavioral biases and a few things happens. First of all, it's human nature because we're overconfident that we think about like, oh, other people do these. Like, oh, these other silly people that are doing risk seeking behavior when they're at a loss or these silly people that have hindsight bias or succumb to confirmation bias, etc. So we first of all think that we're not as bad as everybody else. And so we need to be like, no, we're as bad. I'm human just like everybody else. But then the other thing that's sort of insidious is, once you read about these biases, you think that now that you know them, that you're going to be better at them. And what I've found is, you know, like I have this professional certificate where a lot of studying research, it wasn't actually, you know, like a multi-year sort of thing. So maybe it sounds more impressive than it is. But you know, in prep for that, but also over the years, I've probably read, I don't know, 15 books on behavioral biases and behavioral aspects of investing and the like. And every time I read about it, I think, oh, okay, I got this, you know, I got this, right? I'm going to be I'm going to be better. And I'll tell you, I think I've gotten a bit better just because I've done so much study over the years. But this, I think this idea that you can read, you know, like one book or one paper or like my book, one chapter and like, okay, you've got this, you know, you're going to make this big improvement, you know, to realize that these are hardwired into us. And you know, a thing I hit in my book is some of the reasons why that is. And I think, you know, behavioral economics and behavioral finance or whatever you want to call it, tend to talk about these biases and then heuristics, which means, you know, this shortcut that you make, the shortcuts you make and decision making, you know, they talk about them like in this way, like, aren't we flawed? You know, most of the books. But really, if you dig into like evolutionary psychology, you know, there's really good reasons why we have these biases. And it's because having these biases helped in terms of our survival. So we've evolved to have them. But the situation we are in now is that like we have these ancient brains that evolved to be in this time period of, you know, thousands or hundreds of thousands of years ago. But we live in modern times where, you know, we're not being stalked by prey. And we have all this abundance. And you know, we feel these, you know, these biases come into play on our decision making when so many of them just aren't as applicable anymore. And that's that's really our struggle. Because if you think about like loss aversion, those ancestors of ours that took action not to lose are the ones that were more likely to survive. Because, you know, back in the day, we'll call it like the caveman days, a mistake could easily lead to your death, or at least your inability to reproduce and, you know, past your your genes down. And it was the ones that were more risk adverse in an incredibly treacherous world that survived and passed on their genes. And we are their descendants, right? So there's a very good reason for us to be loss adverse. But again, as an investor, for most people, it just doesn't make sense to give outsized, focused and emotion to losses as compared to gains in this world of abundance that we live in. And another behavioral bias that I really enjoyed learning more about was how we're just naturally drawn to a really good story. And with a lot of investments, people, you know, have almost perfected the art of telling a good story around it to almost pitch it. So what should we know about storytelling to help prevent us from being persuaded into a potentially poor investment? So this is something that isn't talked about a whole lot when it comes to investment and behavioral biases. And it a bit falls under the, you know, what's more commonly known as like base rate neglect. I just think calling it storytelling bias adds a different, you know, spin to it that is first of all, sounds more interesting than base rate neglect. But it also, you know, flips it and highlights why we neglect base rates. And so storytelling bias, you know, it's interesting. I read this book called Tell Me a Story by this AI pioneer named Roger Schenk. And he wrote a book, this book Tell Me a Story 1995. So if you think about it, 1995, and compared to what's going on with AI today, you know, like in 1995, we had had, you know, I think the, you know, definitely the first maybe the second Terminator movie and some science fiction, but you know, really hadn't done much in the way of artificial intelligence but what he says in this book, which is fascinating, is one of the big challenges with AI and AI passing what's known as the Turing test. And the Turing test is was something formulated by Alan Turing. So, you know, he was famous in the, the 40s as one of the big code breakers in Britain and the, you know, Enigma machine and is, is arguably the creator conceptually of, you know, modern day computers. But he had created this test of will there be a time period someday? How can a computer trick a human to think that they're interacting with another human? Right. So that's passing the Turing test. And there's like movies like like X, Mac and, which is just a great movie about the sort of thing. So, you know, Roger Schenk was writing one of the big challenges or maybe the big challenge with AI passing the Turing test is that the way that humans interact is we tell each other story. So I'll tell you a story of something that's happened. And you'll tell me one back. And your, your story back will typically be relevant to my story. And what that story will do will convey to me that you've heard me and you understand. And then I'll tell you one back and we'll go back and forth. And in fact, we judge each other's intelligence by the quality of stories that we tell. So like, if you go out and you meet a person or if you're somebody that's dating and you go on a date and then afterwards someone says, Oh, you know, how intelligent was Carl, you won't realize it. But the way that you will evaluate Carl's intelligence is what quality of stories did Carl tell me? How well of a relevant, relevant, were they to mine, etc. And the reason we evolved to be storytellers is because again, it comes back to a survival advantage, everything else evolutionary. And there are other mammals or animals that work in small groups. But humans are the only species that works in a large scale group. So, you know, there's something called Dunbar's number that you can really only know 150 people or know, you know, know them by name and by parents and know something about them. Right. But if you think about it, we have all these groups that are much bigger, you can work for a company. You know, I used to work for Arthur Andrews. We had 88,000 employees and I identified as an Arthur Anderson employee. And there were certain stories about how we served clients and what we did or, you know, nations, like there's certain narratives and stories around, you know, being an American or, you know, being a Brit, a Canadian, etc, etc. And religions as well, you know, there's certain stories that different religions have, you know, about creation and what the religion stands for and etc, etc. So, we can believe as a species, all these things. And what that allows us to do is it allows us to work in bigger groups and to have shared myths and shared experiences. And so because of all this, we pay outsized attention to stories. And what this means from an investment perspective and just making decisions in everyday life is that we rarely stop to consider the base rate of, you know, what's happening. So, you know, I'll give you an example. Yeah, go ahead. Could you just briefly define what a base rate is? I feel like this is a topic that isn't discussed too often. I first learned it from Buffet and I think it's just an incredible insight. So please define what a base rate really is. Really, it's comes down to statistics, like what is the probability of something happened in a given situation? So for instance, you know, we needed to send my daughter's passport to her. So she's my younger daughter's office at school and is applying to study abroad. And we were discussing, you know, should we wait till she came home for spring break? Or should we like UPS or FedEx at tour? And it was interesting, my wife made a good point. She said, you know, I read the story that popped up on, you know, social media of somebody that was FedExing something really important. I forget now what it was and how it got lost. And like it was something that was basically, you know, irreplaceable. And so I don't think we should FedEx the passport if it got lost, this would be horrible. And you know, I ended up agreeing with her. I said, yeah, the risk is too high. Like if the passport gets lost, like she may not be able to get a replacement in time and to get a visa into study abroad. So we decided to wait till she came home a few weeks later, you know, which had a negative effect on the timeline. But really another way of thinking about it is we could have researched what's the base rate? Like how many FedEx envelopes go missing? And we could have weighed this one story that we heard of this person on social media that had something irreplaceable lost by FedEx. We could have weighed that against the, you know, the point 001%. I haven't looked it up. So I don't know what it is chance it would have been lost. But neither of us did that. It was only later, you know, that I was actually thinking about, oh, we didn't apply it, you know, the base rate and other base rates are things like the vast majority of startup businesses fail, like less than 30% of it make it to their 10th anniversary, or the majority of stocks publicly traded stocks underperform the market. So over any given year, any given 10 or 20 or time period, now two thirds, three fourths, even an 80% of stocks underperform the market. So like you would use that base rate to inform, should I be buying a single individual stock or even five, knowing that the chances are that most if not all the stocks I will pick will underperform the market over the next, you know, 10 or 20 years. So it behooves us as investors to think of the base rate. But the problem we run into is because we're primed to pay attention to stories. We first of all, we hear stories of other investors making outsized returns. Our friends typically talk to us if they're going to talk about investment, about their investment victories, etc, etc. But also we're being sold stories, we're being told stories, even if you're just looking at investing in a single stock, the company has a story to tell us part of their marketing. They may not necessarily be in trying to sway investors, but you know, they're putting forth like, you know, just think about like Facebook, which is now, you know, meta platforms kind of based on the whole metaverse concept. Like, they're putting out the story of what they see the future being and how they're going to take advantage of that. And so if you said, I'm going to spend any time at all reading about whether I should buy meta stock, you're going to get the story about the future that they're going to be selling you. And we hit this as investors all the time. And in my book, I think the most fascinating study on this that I've read was one of medical decision making, where basically they told these volunteers, you have a fictitious disease, and there's two different drugs. One has a 50% effectiveness rate, and then the other one they would vary. And the other one, let's say it has a 90% effectiveness rate. So they'd be like this, Clay, you have a disease, it will kill you left untreated drug A has a 50% effective rate drug B has a 90% effective rate. But then they tell you two stories about the 50% drug they would tell you a neutral story. Chris has taken the drug, we don't know if it's going to work. The second drug, Pat has taken the drug, it's not working, she's blind and can no longer walk and her death is imminent. All right, so based on that, most people in this situation picked the 50% effective drug instead of the 90% effective. Like the 90% effective drug is based on clinical trials and FDA approval and all this, blah, blah, but one story swayed most people to pick the less effective drug because there was a negative story attached. And when they said this drug B is 30% effective and told a positive story, like 80% of people still pick the less effective drug because the positive story was attached. So it's not even just an investment concept. And what I think is fascinating, and as a dug into the storytelling bias is pay attention. I say this all the listeners, pay attention to how when you interact with people, you tell each other stories. And then when you go to make a decision, how you're almost certain to pull out a single story that you heard, a new story, something you heard on social media, something you heard from a friend to inform your decision. And you probably won't go research what the base rate is, which is how often what really happens in the real world and how that should affect your decision. And I'll tell you, I do it too. I've become expert on the storytelling bias. And I laugh at myself how often I succumb to it like I did with the FedEx story that I just told. So again, I feel good with our decision because we couldn't take the risk of not, I'm not FedExing the passport. But I didn't stop to consider the base rate. I jumped into the story was like, Oh, I don't want that to happen. Great story, honey. It's really hard. Yeah, I mean, I think the case of the IPOs is a perfect example where an IPO might have a great story and it might make a ton of sense to you. But if you invest, you should keep in mind that the base rate is really low for the success of IPOs. And then there's all these incentives for, you know, the investment managers trying to pitch it and the company wanting to get a lot of attention. But I don't want to hold you too long. And I wanted to ask you a couple questions since you're in the wealth management industry. We've had a number of guests on the show that I've claimed what I'll call the death of the 60 40 portfolio. Now that inflation is here to stay, and there's all these reasons for why it structurally may be around for the years to come. I just wanted to ask if you have adjusted your portfolio or your client's portfolios to account for a potential inflationary environment or regime, if at all. Yeah. So again, a little bit about our company. So we're a multifamily office. We oversee help our clients with about $15 billion of wealth and about again, about 63 client families we work with. So that's a bit about what we do. And we don't really have, you know, here's our exact model portfolio we should do for clients. It's pretty costive and based on what they need in terms of cash flow and things. But that being said, we don't have many portfolios that are 60 40. You know, we tend to be the kind of eight, when we're like the 80 20 or 70 30, sometimes 90 10, sometimes 95 five, it just really depends on the client. But as we've dug into inflation, which we've done, you know, numerous times over our 21 year history, there's a few interesting things about inflation. First of all, you know, economists still debate what causes inflation exactly and what to do about it. So it's pretty interesting. And what is the big driver of inflation also tells you what asset classes might do better versus not. So it's kind of tough. You can look back into the 70s where you really had this cost push inflation. A lot of us driven by the oil crisis. And you know, you had these high labor costs, you had a lot of labor unions in the 70s, that, you know, a much higher percentage of workers were in labor unions. So it was really hard when there was, you know, low economic growth or declining profitability, you couldn't really cut wages and things. So that was like one situation. And we've had different situations that have been more driven by monetary policy. So, you know, the Fed, you know, being too loose for too long. And then you have, you have times like we have now that are probably a combination of a bunch of different things is, you know, part partly driven by monetary policy, but definitely fiscal spending in the rescue that was done out of COVID, but then combined with all these supply chain issues. And you know, in each era, you can't just say, this is the investment asset that's going to work. I mean, you look at tips, treasury inflation, protective securities, you know, and those haven't done well over this inflationary time period, because this inflation adjustment has been overwhelmed by, you know, the rise of interest rates and there wasn't a, you know, a buffer. So it's tough to say exactly what you should be in as an inflation edge. I'll tell you, during all these time periods, if you look long term, the best performer relative to inflation has just been equities. So whether public equities are private equities. So we've pretty much have stuck to our original, you know, asset allocations with clients. We know that, you know, their time periods is not going to look as good in others that it's going to look better. I'll tell you, like, for the history of our firm, we've had an allocation to non-US stocks. And, you know, that was great in the aughts, but since the financial crisis until 2022, and so far this year, it's been a huge drag while clients going, oh, my gosh, like, you know, will the pain never end? And if we're like, you know, let's continue to rebalance and buy more international stocks and it'll cycle back. And that's really how we view, you know, these asset allocations. And, you know, for instance, if we had a client that's 60, 40, we would say the best investment behavior you can have is not out-guess it and to continue to rebalance back to 60, 40. Yeah, it's been, you know, it was 2022 was brutal for a bond investor, but, you know, bonds are looking more attractive now, you know, they're going to look, you know, better and worse over time. So we're really about behavior, you know, what's, you know, what gives you the best behavior. And we find for investors, it's having more of a static asset allocation and trying not to out-guess. And we've done a lot of paying attention to what other firms do in terms of their tactical allocations. And they're right sometimes, but they're wrong a lot. And, you know, a lot of times they don't work out. And I think an issue is investors feel like they should be doing something when most of the time the better thing to do is not to do anything. So, you know, I think, you know, people worried about inflation and interest rates and allocation of the portfolio are better just to back up and think more in like 20 and 40 and 50 year time frames and just realize, you know, an important mental model is you're not going to, you're going to be wrong as much or more than you're going to be right probably. And again, not have overconfidence and realize that there's all these other people that are in the market. And the price of everything is established by buyers and sellers. And, you know, people tend to think, oh, well, I know more than these other people do. You know, when I'm selling a stock, whoo, and look at those dumb buyers or, you know, vice versa and have a little bit more humility and say there's all these other people, all these other firms and realize that they have a reason for what they're doing. And that's part of the thing that's setting that's it's setting the path of interest rates and it's setting what's happening in the in the stock market and realizing that maybe, you know, you don't know more than they do. And maybe even if you did, would that really help you? So I think it's just a big healthy dose of humility. Well, John, thank you so much for coming on the show. This was absolutely wonderful. If the audience enjoyed this episode, I didn't encourage you to go check out John's new book, the Uncertainty Solution. John, before I let you go, how about you give the handoff to learn more about you and learn more about your book and whatever other resources you'd like to send them to? Yeah, so I have a website that is johnmgenings.com. JOHN, M is in Michael, jinnings.com. And it has a little bit about my book, but importantly, in the menu, there's a tab that says iFOD, which stands for interesting fact of the day. And that is my blog that about twice a week I write on things that have usually nothing to do with investing. They're just things that people, you know, might find interesting. So it's very, very wide ranging. Some of my most popular ones have been what happens to a bullet shot straight up in the air. Why do females usually have neither handwriting than males? Why do competitors often put stores close to each other? Like why do you see a CVS and Walgreens on the same block or a Lowe's and Home Depot? You know, why does that happen? So yeah, it's just, you know, various interesting things like that would, you know, love always to have more subscribers to my blog. Awesome. Well, thanks again, John. Really appreciate it. Yeah, thanks Clay. Enjoyed it. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or report on state. Bye!