Marc Andreessen tweeted something great last week:
I love this. So much of success relies on your ability to learn. But learning can begin with good intentions and quickly backfire, because what caused something to fail or succeed is often specific to one scenario and can't be extended to other examples. It's hard to learn whether a company was brilliant or stupid based on outcomes — and it's even harder to extend those lessons to future investments — because so much of what happens at one company is specific to that company, not to mention driven by chance and odds that could have gone a different way.
A lot of people wonder why investors never learn their lessons after bubbles burst. But as Jason Zweig of the Wall Street Journal explained to us a few months ago, people do learn lessons; they just interpret they too specifically. "People are too good at learning lessons," he said. "They learn overprecise lessons." Investors didn't learn to stay away from leverage and hype after the financial crisis, which was the real lesson. They learned to stay away from subprime bank stocks, which was hyperspecific and probably won't do them much good in the next crisis.
The result is that we often think we're learning lessons to apply to the real world, but we may just be observing randomness that's unique to one event. There's a financial corollary to Newton's Third Law of Motion: Find an investing lesson of why something works, and I'll show you an equal and opposite example of why it doesn't.
Some examples:
- IBM has grown by constantly getting into new products lines to stay relevant. Which is exactly what almost killed AIG.
- Altria has produced phenomenal returns by funneling almost all cash flow back to investors, rather than investing in its operations. Which is the same philosophy that has nearly put Sears out of business.
- Amazon has succeeded because it has ignored the pursuit of profit and focused on growing revenue at all costs. Which is an attitude that would crush nearly any other company.
- Lehman Brothers failed because of its liberal use of debt. But liberal use of debt is one reason companies profiled in the book The Outsiders achieved huge success.
This is also true for investing techniques. Warren Buffett got rich by ignoring macroeconomics and focusing on long-term businesses. George Soros got rich by obsessing over macroeconomics and short-term fluctuations.
There are 150 million workers in this country supporting over 300 million people, 29 million businesses — 80% of which will fail in the first three years — 11,000 lobbyists, 1.2 million lawyers, 70,000 pages of tax code, and half a million annual patent applications. The more complicated something is, the harder it is to determine cause and effect. So you can imagine how difficult it is to determine cause and effect in business and investing.
Part of the problem is that the traits needed for success are also the traits that get people into trouble. Success requires forgoing conventional wisdom, but forgoing conventional wisdom also dramatically increases the chances of failing. This works exponentially: Enormous success require businesses to take enormous risks, and enormous risks usually lead to enormous failures. It's hard to pinpoint exactly what led to success or failure because the same traits often lead to both.
This doesn't mean we shouldn't analyze successes and failures. But in a complicated world, learning hyperspecific lessons is the greatest cause of becoming fooled by randomness. The way to success in complex systems isn't to drill down deeper; it's to pull back and look broader.
Everything I've learned in finance points to the idea that the broadest and simplest lessons are the most important and effective. Things like:
- How people fool themselves.
- How investors get in their own way.
- How corporate culture creates a place where talented people want to work.
- How business success is built on solving customers' problems.
- How fiercely competitive capitalism is.
- How gullible we are.
- How impatient we are.
- How quickly things change.
- How unexpected that change is.
- How investors and businesses respond to stress, change, surprise, and failure.
That's where you learn the most effective financial lessons. The rest is details.
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