Investors: Second Level Thinking

I’m back today with an important piece for investors.

Question: How often do you find yourself considering companies like Apple, Amazon, and Tesla as good investments? If often, how much time and effort have you actually put into analyzing these companies? How much of your investment interest is influenced by social trends and recent price movements?

When it comes to investing, Second Level Thinking (SLT) gives you the ability to think differently than others, uncovering opportunities and hopefully taking advantage of the inefficiencies in present market views. The focus of this post is to emphasize the importance of SLT in investing and to give a simple guide for when investment decisions are being made.

SLT is a concept I’ve been following for years, but was referenced perfectly in The Most Important Thing by Howard Marks — I can’t emphasize enough how important it is. For real value creation to occur, an investor must be able to see, and invest, in things that others don’t. You need to be a correct contrarian — Holding a non-consensus view, and being correct in that view, is what will allow for superior results. Although it’s important not to forget the various other aspects of investing (quantitative related), being able to think differently and question the status quo will be your biggest advantage. Remember that everyone has the same information available, it’s what you can do with it that will make the difference.

An example of SLT would be this: “Bitcoin has been soaring, however, I think the public hype has inflated the price and I’m going to wait for a correction before making any decisions. The current lack of integration and plethora of long-term concerns make me believe that it is a poor investment at the moment. Based on the incredibly long transaction times (which have already been beaten by competitors such as Litecoin), the volatility surrounding the price (preventing it from being used as a stable currency), and the inability to actually spend it anywhere (lack of actual social value), Bitcoin is too ahead of its time and will be beat by a more refined competitor when the time comes for cryptocurrencies/blockchain to take over”

To contrast this, we can look at First Level Thinking (FLT), which is the mindset a large portion of investors follow (hopefully not you though!) FLT entails hearing/reading a headline, or thinking an idea, and following through with it before doing any serious background research/thinking to see where mistakes may be made/opportunities may be available. FLT differs from SLT in that it doesn’t allow you to oppose the general consensus, you’ll only ever do as good as the masses.

Here’s an example of FLT: “Bitcoin has been soaring, better get in before it’s too late!”

Short and sweet right? No.

First Level Thinking will often lead to poorly timed investments — once a company is recognized socially as a good investment, all potential has been factored into the current price. FLT will only allow you to travel with the herd, and although positive during bullish times, you can expect to get trampled the moment things turn.

Now, considering that correct SLT will produce superior results, it is proper to assume that it will also take a considerably larger amount of time and effort. To help speed up the process, Marks prepared a simple 9-step list that outlines the truly important factors of mental analysis. When making an investment decision, ask yourself these 9 questions to get an idea of where you stand.


Second Level Thinking

  1. What is the range of likely future outcomes?
  2. Which outcome do I think will occur?
  3. What’s the probability I’m right?
  4. What does the consensus think?
  5. How do my expectations differ from the consensus?
  6. How does the current price of the asset agree with the consensus’ view of the future? and mine?
  7. Is the consensus psychology incorporated in the price too bullish or bearish?
  8. What will happen to the assets price is the consensus turns out to be right?
  9. What will happen if I turn out to be right?

 

A successful investor will be able to run through these steps, and by the end, have an idea for their chances of success. Second Level Thinking is a mindset/framework that I have been applying to my investments for some time, and the confidence/conviction that you can have in your decisions knowing that you thought everything through will make all the difference.

Proper utilization of Second Level Thinking will offer a massive advantage over others, and although it is only one of many tools you’ll need in order to prosper, I believe it to be one of the most important.

“Everything should be made as simple as possible, but not simpler” – Albert Einstein

 

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