Latticework: The New Investing by Robert Hagstrom

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Key Takeaways

  1. Latticework
    1. Latticework is itself a metaphor. And on the surface, quite a simple one at that. Everyone knows what latticework is, and most people have some degree of firsthand experience with it. There is probably not a do-it-yourselfer in America who hasn't made good use of a four-by-eight sheet of latticework at some point. We  use it to decorate fences, to create shade over patios, and to support climbing plants. It is but a very small stretch to envision a metaphorical lattice as the support structure for organizing a set of mental concepts
  2. Physics - Equilibrium
    1. Physics is the science that investigates matter, energy, and the interaction between them - the study, in other words, of how our universe works. It encompasses all the forces that control motion, sound, light, heat, electricity, and magnetism, and their occurrence in all forms, from the smallest subatomic particles to entire solar systems. It is the intellectual foundation of many well-recognized principles such as gravitation and such mind-boggling concepts as quantum mechanics and relativity.
    2. Equilibrium is defined as a state of balance between opposing forces, powers, or influences. An equilibrium model typically identifies a system that is at rest; this is called "static equilibrium."
    3. The concept of equilibrium is so deeply embedded in our theory of economics and the stock market, it is difficult to imagine any other idea of how these systems could possible work...One place where the question is being raised is the Santa Fe Institute, where scientists from several disciplines are studying complex adaptive systems - those systems with many interacting parts that are continually changing their behavior in response to changes in the environment...If a CAS is, by definition, continuously adapting, it is impossible for any such system, including the stock market, ever to reach a state of perfect equilibrium. What does that mean for the stock market? It throws the classic theories of economic equilibrium into serious question. The standard equilibrium theory is rational, mechanistic, and efficient. It assumes that identical individual investors share rational expectations about stock prices and then efficiently discount that information into the market. It further assumes there are no profitable strategies available that are not already priced into the market. The counterview from SFI suggests the opposite: a market that is not rational, is organic rather than mechanistic, and is imperfectly efficient. 
    4. The SFI pointed out 4 distinct features they observed about the economy: dispersed interaction, no global controller, continual adaptation, out of equilibrium dynamics. 
  3. Biology - Evolution
    1. What we are learning is that studying economic and financial systems is very similar to studying biological systems. The central concept for both is the notion of change, what biologists call evolution. The models we use to explain the evolution of financial strategies are mathematically similar to the equations biologists use to study populations of predator-prey systems, competing systems, or symbiotic systems. 
    2. Complex systems must be studied as a whole, not in individual parts, because the behavior of the system is greater than the sum of the parts. The old science was concerned with understanding the laws of being. The new science is concerned with the laws of becoming
  4. Social Sciences - Complexity, Complex Adaptive Systems, Self-Organized Criticality
    1. Although Johnson's maze is a simple problem-solving computer simulation, it does demonstrate emergent behavior. It also leads us to better understand the essential characteristic a self-organizing system must contain in order to produce emergent behavior. That characteristic is diversity. The collective solution, Johnson explains, is robust if the individual contributions to the solution represent a broad diversity of experience in the problem at hand. Interestingly, Johnson discovered that the collective solution is actually degraded if the system is limited to only high-performing people. It appears that the diverse collective is better at adapting to unexpected changes in structure. 
      1. Folly to think you can eliminate every waste, every performer who doesn't meet the highest bar, and excel and survive. Can shift the entire bell curve to the right, but you still need the full spectrum
      2. Notes: We have observed anecdotal evidence of emergent behavior, perhaps without realizing what we were seeing. The recent bestseller, Blind Man's Bluff: The Untold Story of american Submarine Espionage, presents a very compelling example of emergence. Early in the book, the authors relate the story of the 1966 crash of a B-52 bomber carrying four atomic bombs. Three of the four bombs were soon recovered, but a fourth remained missing, with the Soviets quickly closing in. A naval engineer named John Craven was given the task of locating the missing bomb. He constructed several different scenarios of what possibly could have happened to the fourth bomb and asked the members of the salvage team to wager a bet on where they thought the bomb could be. He then ran each possible location through a computer formula and - without ever going to sea! - was able to pinpoint the exact location of the bomb based on a collective solution
    2. It is when the agents in the system do not have similar concepts about the possible choices that the system is in danger of becoming unstable. And that is clearly the case in the stock market...The value of this way of looking at complex systems is that if we know why they become unstable, then we have a clear path to a solution, to finding ways to reduce overall instability. One implication, Richards says, is that we should be considering the belief structures underlying the various mental concepts, and not the specifics of the choices. Another is to acknowledge that if mutual knowledge fails, the problem may center on how knowledge is transferred in the system. 
  5. Psychology - Mr. Market, Complexity, Information
    1. Another aspect of behavioral finance is what some psychologists refer to as mental accounting - our tendency to think of money in different categories, putting our funds into separate "mental accounts," depending on circumstances. Mental accounting is the reason we are far more willing to gamble with our year-end bonus than our monthly salary, especially if it is higher than anticipated. It is also one further reason why we stubbornly hold onto stocks that are doing badly; the loss doesn't feel like a loss until we sell
  6. Philosophy - Pragmatism
    1. Strictly for organizational simplicity, we can separate the study of philosophy into 3 broad categories. First, critical thinking as it applies to the general nature of the world is called "metaphysics"...Metaphysics means "beyond physics." When philosophers discuss metaphysical questions, they are describing ideas that exist independently from our own space and time. Examples include the concepts of God and the afterlife. These are not tangible events like tables and chairs but rather abstract ideas that metaphysical questions readily concede the existence of the world that surrounds us but disagree about the essential nature and meaning of the world. The second body of philosophical inquiry is the investigation of 3 related areas: aesthetics, ethics, and politics. Aesthetics is the theory of beauty. Philosophers who engage in aesthetic discussions are trying to ascertain what it is that people find beautiful, whether it be in the objects they observe or in the state of mind they achieve. This study of the beautiful should not be thought of as a superficial inquiry, because how we conceive beauty can affect our judgments of what is right and wrong, what is the correct political order, and how people should live. Ethics is the philosophical branch that studies the issues of right and wrong. It asks what is moral and what is immoral, what behavior is appropriate and inappropriate. Ethics makes inquiries into the activities people undertake, the judgments they make, the values they hold, and the character they aspire to achieve. Closely connected to the idea of ethics is the philosophy of politics. Whereas ethics investigates what is good or right at the individual level, politics investigates what is good or right at the societal level. Political philosophy is a debate over how societies should be organized, what laws should be passed, and what connections people should have to these societal organizations. Epistemology, the third body of inquiry, is the branch of philosophy that seeks to understand the limits and nature of knowledge. The term itself comes from two Greek words: episteme, meaning "knowledge," and logos, which literally means "discourse" and more broadly refers to any kind of study or intellectual investigation. Epistemology, then, is the study of the theory of knowledge. To put it simply, when we make an epistemological inquiry, we are thinking about thinking. When philosophers think about knowledge, they are trying to discover what kinds of things are knowable, what constitutes knowledge (as opposed to beliefs), how it is acquired (innately or empirically, through experience), and how we can say that we know a thing.
    2. For pragmatism, anyone who seeks to determine the true definition of a belief should look not at the belief itself but at the actions that result from it. He called the proposition "pragmatism," a term, he pointed out, with the same root as practice or practical, thus cementing his view that the meaning of an idea is the same as its practical results. "Our idea of anything, Peirce explained, "is our idea of its sensible effects." In his classic 1878 paper, "How to Make Our Ideas Clear," Peirce continued: "The whole function of thought is to produce habits of action. To develop its meaning, we have, therefore, simply to determine what habits it produces, for what a thing means is simply what habits it involves." 
    3. A belief is true, James said, because holding it puts a person into more useful relations with the world...People should ask what practical effects come from holding one philosophical view over another
    4. If truth ad value are determined by their practical applications in the world, then it follows that truth will change as circumstances change and as new discoveries about the world are made. Our understanding of truth evolves. Darwin smiles.
    5. So we can say that pragmatism is a process that allows people to navigate an uncertain world without becoming stranded on the desert island of absolutes. Pragmatism has no prejudices, dogmas, or rigid canons. It will entertain any hypothesis and consider any evidence. If you need facts, take the facts. If you need religion, take religion. If you need to experiment, go experiment. "In short, pragmatism widens the field of search for God," says James. "Her only test of probable truth is what works best in the way of leading us." 
    6. Pragmatism, in summary, is not a philosophy as much as it is a way of doing philosophy. It thrives on open minds, and gleefully invites experimentation. It rejects rigidity and dogma; it welcomes new ideas. It insists that all possibilities should be considered, without prejudice, for important new insights often come disguised as frivolous, even silly notions. it seeks new understanding by redefining old problems. 
    7. One of the secret to Bill Miller's success is his desire to take a Rubik's Cube approach to investing. He enthusiastically examines every issue from every possible angle, from every possible discipline, to get the best possible description - or redescription - of what is going on. Only then does he feel in a position to explain. To his investigation he brings insights from many fields...He continually studies physics, biology, and social science research, searching for ideas that will help him become a better investor...In an environment of rapid change, the flexible mind will always prevail over the rigid and absolute...Because you recognize patterns, you are less afraid of sudden changes. With a perpetually open mind that relishes new ideas and knows what to do with them, you are set firmly on the right path. 
  7. Literature - self-education of a Latticework through books, Adler's Active Reading
    1. We must educate ourselves and the vehicle for doing so is a book supplemented with all other media both traditional and modern...So we are talking about learning to become discriminating readers: to analyze what you read, to evaluate its worth in the larger picture, and to either reject it or incorporate it into your own latticework of mental models...We can all acquire new insights through reading if we perfect the skill of reading thoughtfully. The benefits are profound: not only will you substantially add to your working knowledge of various fields, you will at the same time sharpen your skill at critical thinking.
    2. The central purpose of reading a book, Adler believes, is to gain understanding...This is not the same as reading for information. 
    3. Reading that makes you stop and think is the path to greater understanding - not solely because of what you are reading but also because of the process of reflection in which you are engaged. You are learning from your own thinking as well as from the author's ideas. You are making new connections. Adler describes as the difference between learning by instruction and learning by discovery. It's evident of in the satisfaction we feel when we figure out something on our own, instead of being told the answer. Receiving the answer might solve the immediate problem, but discovering the answer by your own investigation has a much more powerful effect on your overall understanding. 
    4. Adler proposes that all active readers need to keep 4 fundamental questions in mind: what is the book about as a whole, what is being said in detail, is the book true, in whole or in part, what of it? The heart of Adler's process involves 4 levels of reading: elementary, inspectional, analytical, and syntopical. Each level is a necessary foundation for the next, and the entire process is cumulative. 
      1. Elementary reading is the most basic level, the one we achieve in elementary education
      2. In inspectional reading, the second level, the emphasis is on time and the goal is to determine, as quickly as possible, what the book is about. It has two levels: prereading and superficial reading. Prereading is a fast review to determine whether a book deserves a more careful reading. Look at the table of contents, index, how much can you learn about the main themes through this overview. Next, Adler recommends systematic skimming. Read a few paragraphs here and there, read the author's conclusion. These two activities should take between 30-60 minutes and help you determine if it is worth your time to read the book
      3. Analytical reading is the most thorough and complete way to absorb a book. Through analytical reading you will answer what is the book about as a whole and in detail and provide you the most complete answer to if the book is true. It has  goals: develop a detailed sense of what the book contains, interpret the contents by examining the author's own particular point of view on the subject; and to analyze the author's success in presenting that point of view convincingly. Take notes, make an outline, write in your own words what you think the book is about, write the author's main arguments
      4. The fourth and highest level is what Adler calls syntopical reading, or comparative reading. In this level of reading, we are interested in learning about a certain subject, and to do so we compare and contrast the works of several authors rather than focusing on just one work by one another. Adler considers this the most demanding and most complex level of reading. It involves two challenges: first, searching for possible books on the subject; and then deciding, after finding them, which books should be read
    5. The challenge for us as readers is to receive that knowledge and integrate it into our latticework of mental models. How well we are able to do so is a function of two very separate considerations: the author's ability to explain, and our skills as careful, thoughtful readers. We have little control over the first, other than to discard one particular book in favor of another, but the second is completely within our control
    6. I believe in...mastering the best that other people have figured out, [rather than] sitting down and trying to dream it up yourself...You won't find it that hard if you go at it Darwinlike, step by step with curious persistence. You'll be amazed at how good you can get...It's a huge mistake not to absorb elementary worldly wisdom...Your life will be enriched - not only financially but in a host of other ways - if you do. - Charlie Munger, Poor Charlie's Almanack 
  8. Decision Making - Continuously add more building blocks to your knowledge base in order to build more robust mental models
    1. Failures to explain are caused by our failures to describe
    2. Our institutions of higher learning may separate knowledge into categories, but wisdom is what unites them.

What I got out of it

  1. A beautiful book on how to approach being a multidisciplinary thinker as it applies to investing.