Investing: The Last Liberal Art by Robert Hagstrom

Summary

Hagstrom walks the reader through why and how to incorporate fundamental principles from multiple fields to become a better thinker, decision maker, investor, etc.

Key Takeaways

Worldly Wisdom
1. Combine key ideas from all disciplines and then develop a latticework in head to ‘hang’ all mental models on
2. Chances of good decisions improve when many, disparate models yield the same conclusion
3. Educate self and then train to see problems by seeing/thinking differently
  1. Learn big ideas so well that they are always with you
4. Key is finding linkages and connecting one idea to another
  1. Connectionism – we learn by analogy, more connections leads to more intelligence
  2. Massive number of connections more efficient than raw speed (small world networks are everywhere)
5. Two keys to innovative thinking – understand basic disciplines we draw knowledge from and be aware of the benefits and uses of metaphors
  1. Concise, memorable, colorful way to depict thought, action, ideas and more importantly translate ideas into models – stimulating understanding and new ideas
Physics
1. The bridge between equilibrium in physics, economics and the stock market
2. Equilibrium – state of balance between two opposing forces, powers or influences
  1. Static vs. dynamic
  2. Rational actions lead to stock market equilibrium – where the shadow price (intrinsic value) = stock price
    1. Now argue market is complex adaptive system – a network of many individual agents all acting in parallel and interacting with one another. The critical variable that makes a system both complex and adaptive is the idea that agents in the system accumulate experience by interacting with other agents and then change themselves to adapt to a changing environment
      1. Irrational, organic, not efficient
Biology
1. Evolution and natural selection to law of economic selection
2. After crashes, market and economy best understood from a biological perspective as equilibrium could not account for them
3. Struggle between species and individuals of same species leads to natural selection and evolution
4. Schumpter – economics essentially an evolutionary process of continuous and creative destruction
  1. Innovation, a visionary and action-oriented entrepreneur and access to credit are all necessary
  2. Innovation leads to periods of punctuated equilibria – creative destruction
5. 4 distinct features of economy
  1. Dispersed interaction – what happens in the economy is determined by the interactions of a great number of individual agents all acting in parallel
  2. No global controller
  3. Continual adaptation (co-evolution)
  4. Out of equilibrium dynamics – constant change leads to a system constantly out of equilibrium
6. Evolution takes place sin stock market via economic selection and capital allocation
7. Living systems make themselves up as they go along
8. Efficiency and evolutionary / behavioral not necessarily exclusive – times of less emotions leads to more efficient market
Sociology
1. Study of how individuals function in society and ultimate goal is predicting group behavior
2. Relationship between individual investor and stock market a profound puzzle
3. All human interactions and systems are complex adaptive – can’t separate part from the whole and behavior constantly changes as agents and therefore system adapts
4. Self-organization and self-reinforcement found in physics, biology, economics, etc.
5. Emergence – larger entities arise out of interactions of simpler, smaller entities and have characteristics that the smaller entities do not exhibit
  1. Crowds can be collectively intelligent IF diverse and independent
  2. Smart and dumb agents lead to better outcomes than a group of just smart people
  3. Information cascades, which lead to diversity breakdowns happen when people make decisions based on others rather than private information and leads to inefficient system
    1. Can even happen with small groups if have a very dominant leader
  4. Self-organized criticality – market one example where instability is inherent, unpredictable and small fluctuations lead to big changes
    1. Different meta-models of reality (quant vs. fundamentally oriented…) leads to instability
  5. Complex adaptive, self-organization leads to emergence which leads to instability, unpredictability, criticality
Psychology
1. Anchoring, framing, overreaction, overconfidence, mental accounting, loss aversion key biases
2. Equity risk premium is puzzling – people hold bonds because of loss aversion and mental accounting
3. Loss aversion makes people short-term focused
4. Longer investor holds an asset, the more attractive it becomes IF not evaluated frequently – advises checking prices only once per year!
5. Information overload can lead to illusion of knowledge
6. Don’t be Walter Mitty investor – feed during difficult times!
7. Decisions we make based on skill lead to higher risk taking and luck to lower
8. Mental models are imprecise ways of modeling reality but very helpful and simplify life
  1. Mistakes – believe models equiprobable, focus on few or one, ignore what is not easily seen
9. Innate pattern seeking leads to magical thinking and superstitions by people trying to explain the unexplainable
  1. In this case, beliefs precede reasoning, beliefs dictate what you see
    1. Why people listen to forecasters – quells anxiety we hate to live with even if we rationally know how stupid it is
10. Reduce noise via accurate communication of information makes for better rational decisions
  1. Correction device – get information from first-hand sources and then do your best to remove prejudices and biases
Philosophy
1. Forces us to think and can’t be transferred intact from one mind to another
2. Metaphysics – ideas independent of space and time (God, afterlife)
3. Aesthetics / ethics / politics three main branches
4. Epistemology – study of the nature/limits of knowledge; thinking about thinking
  1. Develop rigorous, cohesive epistemological routines
5. Failure to explain caused by failure to describe – Mandelbrot
6. Disorder simply order misunderstood
7. Wittgenstein – world we see is defined and given meaning by the words we choose
  1. Reality is shaped by the words we select
  2. Stories very powerful description tools – beware of the overconfidence they can deliver
8. Pragmatism – true belief defined by actions and habits it produces (William James)
  1. Idea or action is real, good, true if it makes a meaningful difference
    1. Our understanding of truth evolves as it is based on results
    2. No absolutes
Literature
1. Read selectively but analytically
2. Always evaluate its worth in the larger picture and then either reject or incorporate what you learn into your mental models – the importance of reflection!
3. Improves understanding (over fact collecting) and critical thinking
4. Critical mindsets evaluate the facts and separate facts from opinion
5. Fiction important because it helps us learn from others’ experiences
6. Detectives best practices
  1. Develop a skeptic’s mindset; don’t automatically accept conventional wisdom
  2. Conduct a thorough investigation
  3. Begin an investigation with an objective and unemotional viewpoint
  4. Pay attention to the tiniest details
  5. Remain open-minded to new, even contrary, information
  6. Apply a process of logical reasoning to all you learn
  7. Become a student of psychology
  8. Have faith in your intuition
  9. Seek alternative explanations and redescriptions
Mathematics
1. Bayes’ Theorem – updating initial beliefs with new information leads to new and improved belief
  1. AKA Decision Tree Theory
2. Probability theory – analysis of random phenomena
3. Kelly Criterion – how to size bets
  1. 2p – 1 = x (p = probability of winning)
  2. To compensate people not having an infinite bankroll or time horizon, halve (or take some fraction) of the Kelly Criterion
4. Never fail to take variation into account – trends of system vs. trends in system (individual winners even during sideways overall market)
5. Never fail to take into account regression to the mean
Decision Making
1. Intuition helpful when situation is reliable enough to be predictable and when can learn regularities through prolonged practice (mostly linear systems)
  1. Intuition nothing more than recognition – increase store of knowledge and connections leads to improved intuition
2. How you think more important than what you think
3. Humans cognitive misers and stop thinking the minute they’re satisfied with an answer
4. Building blocks from many disciplines used to form mental models must be dynamic and updated with new information

What I got out of it

A fascinating read which was helpful to get a good, broad understanding of what it means to be a multi-disciplinary learner