“Don’t do stupid shit.”
—Barack Obama
Applied wisdom means keeping the number of times you shoot yourself in your foot to a minimum and surviving every single attempt at self-mutilation. It also involves knowledge of life, knowledge of yourself, acknowledgment of uncertainty, open-mindedness, tolerance, coolness, naivete-aversion, discernment, instinct, the ability to see the big picture, diligence, prudence, intellectual thoroughness, courage, tenacity, experience, down-to-earth-ness, reflection, happiness, prosperity, and a sense of humor. Applied wisdom can be earned or learned, but not taught.
Applied wisdom is also the avoidance of folly, unwisdom, faux sophistication, dogma, stupidity, ignorance, arrogance, hubris, and includes doubt, skepticism, and a healthy baloney-detection approach
Foolishness and Mathematized Wisdom
The Boxing Day tsunami of 2004 off the west coast of northern Sumatra killed approximately two hundred and thirty thousand people in fourteen countries. All the science of Western civilization did not help to foresee the earthquake or prevent devastation and death. One interesting aspect of this tsunami was that hardly any members of the aboriginal tribes were killed. They were able to conclude from the behavior of their animals that something bad was about to strike, and they moved inland before the disaster. They applied wisdom.
“Wisdom is the quality that keeps you from getting into situations where you need it.”
—Doug Larson (1926–2017), American columnist
An apple a day keeps the doctor away. This is not just a saying or grandmotherly advice; it is an old piece of wisdom that has traveled well through time and is still applicable today. There are much fancier ways to say that fruit is good for you. Modern science helps us understand why there is truth that an apple, here a proxy for healthy food, is beneficial to our physical health.
Wisdom travels through time. In finance, for instance, modern portfolio theory (MPT) proves the benefits of reducing risk through diversification. However, these benefits have been known for thousands of years. In economics, we did not need to wait for economists to tell us that excess public debt is not good for societal well-being. David Hume knew it three hundred years ago and Solomon three thousand years ago.
This means the applicable wisdom of diversification is ancient, as is the folly of excess leverage and debt. A quotation or a proverb is just the medium that something used to travel through time and survive until today. A quotation, proverb, or saying ought to contain condensed knowledge, experience, and, ideally, wisdom. Miguel de Cervantes, author of Don Quixote, knew this.
“Proverbs are short sayings drawn from long experience.”[i]
—Miguel de Cervantes (1547–1616), Spanish novelist, dramatist, and poet
In the social sciences, as, for example, in economics and finance, academic research is often “mathematized wisdom,” the benefits of diversification being just one example. This book is indeed about capital preservation and risk management, even if some of the excursions might appear to suggest otherwise. Given that the mathematization of old tricks of the trade distorts the wisdom, confuses the practitioner, and adds unnecessary complexity, I often opted for simplicity rather than sophistication. One implicit and important assumption, therefore, is that, as investors, it is better to be street-smart than book-smart:
“A knowledgeable fool is a greater fool than an ignorant fool.”[ii]
—Molière (1622–73), French actor
This old quote is shockingly consistent with the phenomenon of expert failure and dysrationalia, i.e., the concept of really smart people making really stupid mistakes. It is also consistent with the Nobel disease, i.e., the concept of highly educated people like Nobel prize-winners endorsing or performing “research” in pseudoscientific areas in their later years. Award-winning science journalist David Robson even goes as far as suggesting that really smart people can be more perceptible to nonsense or pranks:
“Not only do general intelligence and academic education fail to protect us from various cognitive errors; smart people may be even more vulnerable to certain kinds of foolish thinking.”[iii]
—David Robson (b. 1985), British science writer
Robson reminds us that Albert Einstein was shunned in his later years by other scientists for his foggy thinking and ignorance of facts, and Steve Jobs could still be alive today had he listened to his doctors instead of trying to cure cancer himself with spiritual healing and fruit juice diets.
Practical Wisdom and Faux Sophistication
Wisdom is a path; an ideal. It involves learning, effort, curiosity, intellectual humility and autonomy, open-mindedness, perspective, and failure. Wisdom, like happiness, is not a destination but a journey. Socrates, for example, did not claim to have wisdom, but only to seek it lovingly. He was wisdom’s amateur, not its professional.[iv]
The ancient Greeks had a word for a special type of wisdom, one that was more practical than wisdom or intelligence. They called wisdom with practical applicability phronesis. This was sometimes translated as “practical virtue” and involved both good judgment and excellence of character.
Aristotle, whose philosophy greatly influenced both the Christian and Islamic religions, distinguished between two intellectual virtues: sophia and phronesis. Sophia is designing and constructing a Formula One car. Phronesis is applying the rubber to the tarmac. Sophia is often translated as science; it is serious, logical, teachable, and reasonable. It’s Mr. Spock. Phronesis is much broader, is not teachable, and involves converting theory into practice, diligence, prudence, intellectual thoroughness, courage, tenacity, and experience. It’s a cross between Captain Kirk, Yoda, and Forrest Gump’s mum. Sophia involves searching for universal truths. Phronesis involves good decision-making in real-world situations where there is no playbook to follow. It involves reflection, human flourishing, happiness, and prosperity.
Aristotle’s phronesis is often translated as “practical or ethical wisdom,” which is close to terms such as “worldly wisdom” or “applied wisdom.” At the most simplistic level, applied wisdom means keeping the number of times you shoot yourself in your foot to a minimum and surviving every single attempt of self-mutilation. It also involves knowledge of life, knowledge of yourself, acknowledgment of uncertainty, open-mindedness, tolerance, coolness, naivete-aversion, discernment, instinct, the ability to see the big picture, and a sense of humor. Applied wisdom can be earned or learned but not taught.
Peggy Noonan, a speechwriter to both Ronald Reagan and George H. W. Bush, and to some on the political right, the greatest essayist of our generation, makes the distinction between sophia and phronesis when criticizing Barack Obama’s judgment in an article titled “The Unwisdom of Barack Obama.”
“Mr. Obama can see the trees, name their genus and species, judge their age and describe their color. He absorbs data. But he consistently misses the shape, size and density of the forest. His recitations of data are really a faux sophistication that suggests command of the subject but misses the heart of the matter.”[v]
—Peggy Noonan (b. 1950), American author and columnist
Unwisdom, faux sophistication, and folly, in my book “Applied Wisdom,” from which this post is from, are the opposite of applied wisdom. As investors, we should try to avoid folly. However, in active asset management, where relative performance matters, folly is a prerequisite:
“Let us be thankful for the fools. But for them, the rest of us could not succeed.”[vi]
—Mark Twain (1835–1910), American author and humorist
Warren Buffett, who was rejected by Harvard Business School after graduating from the University of Nebraska, once jested that he would like to fund university chairs in the EMH (efficient market hypothesis) so that the professors would train even more misguided financiers whose money he could win. He called the orthodox theory “foolish” and plain wrong. Yet none of its proponents “has ever said he was wrong, no matter how many thousands of students he sent forth misinstructed. Apparently, a reluctance to recant, and thereby to demystify the priesthood, is not limited to theologians.”[vii]
Meir Statman, a professor of finance who rolls his eyes when friends claim they can distinguish good wines from mediocre wines but is confident that he can easily distinguish good olives from mediocre ones, draws the important link between markets being irrational and the irrationality being helpful for the “rational” among us.
“The market may be crazy, but that doesn’t make you a psychiatrist.”[viii]
—Meir Statman (b. 1947), German-born Israeli American professor of finance
While markets may behave crazily, and while we are not rational, we still try to make sense of things. I believe the following to be both true and the bottom line of any debate on human rationality and efficient markets.
“Man is not a rational animal;
he is a rationalizing animal.”[ix]
—Robert A. Heinlein (1907–88), American science fiction author
Thinkers throughout the ages agree that one cannot apply wisdom without being self-aware, i.e., acknowledging one’s own ignorance to some degree.
Predictable Folly and First Principles
One idea in finance goes by the name “greater fool theory,” which states that the value of a security or asset class does not matter that much as long as you can sell to a greater fool than yourself at an even more ridiculous price than you paid. According to this “theory,” it was perfectly rational to buy Internet stocks in the 1990s, as it was rational to buy Japanese stocks in the 1980s, as it was rational to buy Bitcoins at $20 or $10,000 per coin more recently. Whether financial markets resemble a random walk down Wall Street or not does not matter that much in this regard.
“There is no reason, only mass psychology…. It’s perfectly all right to pay three times what something is worth as long as later on you can find some innocent to pay five times what it’s worth.”[x]
—Burton G. Malkiel (b. 1932), American economist
As with everything else in life, risk is involved. The greater fool theory works if you are not the greatest of fools. This is how the “Oracle of Boston” put it:
“You may find a buyer at a higher price—a greater fool—or you may not, in which case you yourself are the greater fool.”[xi]
—Seth Klarman (b. 1957), American hedge fund manager
Avoiding folly is a first principle:
“The first principle is that you must not fool yourself—and you are the easiest person to fool.”[xii]
—Richard Feynman (1918–88), American physicist
Buying General Electric, Thomas Edison’s company, at $0.5 trillion market capitalization did not work. There is a limit to everything.
“Unfortunately, the greater fool theory only works until it doesn’t. Valuation eventually comes into play, and those who are holding the bag when it does have to face the music.”[xiii]
—Howard Marks (b. 1946), American investor
Even if wisdom is an unreachable ideal, its pursuit is worth it:
“Of all human pursuits the pursuit of wisdom is the most perfect, the most sublime, the most profitable, the most delightful.”[xiv]
—Thomas Aquinas (1225–1274), Italian priest and philosopher
The pursuit of wisdom has many drawbacks, though, the loss of muscle mass being just one:
“If it is wisdom you’re after, you’re going to spend a lot of time on your ass reading.”[xv]
—Charlie Munger (1924-2023)
Investors who can spot folly have an edge over those who cannot, and especially over those who cannot and do not know that they cannot. Folly might even take a bit of randomness out of markets.
“The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable.”[xvi]
—Warren Buffett (b. 1930), American investor and chairman of Berkshire Hathaway
Wisdom and Stupidity
Foolishness is something one can count on: it is not going away. While applied wisdom is scarce, there might be an oversupply of folly:
“There are more fools than wise men;
and even in the wise men more folly than wisdom.”[xvii]
—Sébastien Nicolás de Chamfort (1741–94), French writer
Investors should try to avoid folly, foolishness being the opposite of applied wisdom, as mentioned. Avoiding foolishness is sometimes referred to as the Obama Doctrine:
“Don’t do stupid shit.”[xviii]
—Barack Obama (b. 1961), American politician and forty-fourth president of the United States
Avoiding foolishness is easier than applying wisdom. But then, avoiding foolishness is applying wisdom. The Obama Doctrine can be traced, its “wisdom” old:
“Virtue’s first rule is to avoid vice,
wisdom’s is to not be stupid.”[xix]
—Horace (65–25 bc), Roman poet
Charlie Munger, Warren Buffett’s lifelong partner, who also worked with Warren Buffett’s grandfather, recommends the acquisition of what he liked to call “worldly wisdom”:
“Acquire worldly wisdom and adjust your behavior accordingly. If your new behavior gives you a little temporary unpopularity with your peer group…then to hell with them.”[xxi]
—Charlie Munger
Foolishness can persist for a long time. Trends, therefore, can go on for a long time, but trees do not grow to the sky. Everything ends eventually, but trying to predict the end has widow-making potential.
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The basis of this article is from Chapter 1 in Alexander Ineichen, Applied Wisdom, Radius, 2021.
[i] Quoted in Daniel Weis, Everlasting Wisdom (Trowbridge, England: Paragon Publishing, 2010).
[ii] Original: “Un sot savant est sot plus qu’un sot ignorant.” Les Femmes Savantes (1672), Act IV, sc. iii.
[iii] David Robson, The Intelligence Trap: Revolutionise Your Thinking and Make Wiser Decisions (London: Hodder & Stoughton, 2019), 3.
[iv] Will Durant, The Story of Philosophy (New York: Simon & Schuster, 2006), 7. First published 1926 by Simon & Schuster (New York).
[v] Peggy Noonan, “The Unwisdom of Barack Obama,” Wall Street Journal, September 18, 2014.
[vi] Mark Twain, Following the Equator (1897). There are capacity constraints in active asset management. The investment opportunities are directly related, as Twain implies, to the scale of investor folly in the marketplace. From the perspective of the active manager: the more folly, the merrier.
[vii] From Benoit Mandelbrot and Richard L. Hudson, The (Mis)behavior of Markets: A Fractal View of Risk, Ruin, and Reward (New York: Basic Books, 2004), 14.
[viii] From Jason Zweig, The Devil’s Financial Dictionary (New York: PublicAffairs, 2015), 81. Quotation is in relation to the efficient market hypothesis. Originally in Jason Zweig “Inefficient Markets Are Still Hard to Beat,” Wall Street Journal, January 9, 2010.
[ix] Robert A. Heinlein, Assignment in Eternity (Reading, PA: Fantasy Press, 1953).
[x] Burton G. Malkiel, A Random Walk Down Wall Street (New York: W. W. Norton, 1990), 31–32. First published in 1973.
[xi] Seth A. Klarman, Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor (New York: HarperCollins, 1991).
[xii] Caltech commencement address, 1974.
[xiii] Howard Marks, The Most Important Thing: Uncommon Sense for the Thoughtful Investor (New York: Columbia University Press, 2011), 28.
[xiv] Thomas Aquinas, Summa contra Gentiles, i, 1. From Will Durant, The Story of Civilization, Volume 4: The Age of Faith (Norwalk: Easton Press, 1992). First published in 1950 with Simon & Schuster (New York). An alternative translation reads: “The pursuit of wisdom is more perfect, more noble, more useful, and more full of joy.”
[xv] Whitney Tilson’s 2007 Wesco Annual Meeting Notes.
[xvi] Berkshire Hathaway, Financial Review, 1985.
[xvii] Originally in Maximes et Pensées (1795) published posthumously by his friend Pierre-Louis Ginguené.
[xviii] On a trip to Asia in 2014, the president used a baseball analogy to explain his foreign policy as one that is more focused on “singles and doubles” than home runs. Jeffrey Goldberg from The Atlantic called the quotation the “Obama Doctrine.” “Shit” is often softened to “stuff” when referring to the Obama Doctrine.
[xix] I use a variant of this quote. Original: “Virtus est vitium fugere et sapientia prima stultitia caruisse.” Literally: “To flee vice is the beginning of virtue, and to have got rid of folly is the beginning of wisdom.” Wikiquote contributors, “Horace,” Wikiquote, https://en.wikiquote.org/w/index.php?title=Horace&oldid=2898482 (accessed March 30, 2021).
[xxi] Charles T. Munger, Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger, ed. Peter D. Kaufman, expanded 3rd ed. (Virginia Beach: Donning Company Publishers, 2008).