Friday, June 10, 2011

A note on book reviews, the circle of competence, and our approach to learning

Our group enjoys reading to learn about a variety of topics and we plan on sharing our notes frequently on these digital pages.  At first glance, some of the books and articles mentioned may initially appear completely unrelated to investing.  It is our belief that the most successful investors draw on far more than a sharp pencil and a basic accounting degree.  History, in particular, offers readers the opportunity to learn both from the mistakes of others (which can be far less costly than learning from our own) and gain a better understanding of past human behavior.  We are interested in examining the events, risks, and crisis of previous generations so that we can be better prepared to manage portfolios should history, as it often does, begin to repeat itself. 

This multi-disciplinary approach to knowledge and investing has been developed in detail by Berkshire Hathaway Vice Chairman Charlie Munger.  He explained at length what he refers to as the "latticework" approach in a classic, must read, 1994 speech to the USC Business school, "A lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business."  The heart of his message is that "before you're going to be a great stock picker, you need some general've got to have models across a fair array of disciplines."  To Charlie, a general education consists of models derived from mathematics (especially probability), economics, biology, physics,and engineering among other subjects.  He notes that human psychology (i.e. behavioral finance) is "an ungodly important subject if you're going to have any worldly wisdom" and that "terribly smart people [have made] totally bonkers mistakes by failing to pay heed to it".  While observing the behavior of others is important, it is also critical to understand the limits of our own abilities; "If you play games where other people have the aptitudes and you don't, you're going to lose.  And that's as close to certain as any prediction that you can make.  You have to figure out where you've got an edge.  And you've got to play within your own circle of competence."  To become better investors, we need to constantly work to expand the perimeter of our own circle of competence, and indeed, that is one of the primary goals of this blog.

Further reading on this subject can be found in Robert Hagstrom's, Investing The Last Liberal Art, which uses the latticework approach to connect models from a variety of disciplines back to Investing (below).

As a side note, we will often supply links to when making book recommendations.  If you have an interest in purchasing the book, we encourage you to use our link as we will receive a portion of the purchase price.  100% of the proceeds we receive will be directed to the Punch & Associates charitable foundation, a donor-advised fund that we manage.