“You need to balance arrogance and humility. When you buy anything, it’s an arrogant act. You’re saying: The markets are gyrating and somebody wants to sell this to me, and I know more than everyone else, so I’m gonna stand here and buy it. I’m gonna pay 1/8 more than the next guy wants to pay and buy it. That’s arrogant. And you need the humility to say: But I might be wrong. And you have to do that on everything.” – Seth Klarman (Trades, Portfolio)
When I first heard these words from Seth Klarman (Trades, Portfolio) a few years ago, I thought it was interesting, but could hardly relate to it as I was so inexperienced. As I progressed, I’ve had deeper and deeper understanding of humility and arrogance and much more appreciation of Klarman’s words. Today I’d like to share my experiences and thoughts on humility and arrogance.
When I first started my value investing journey, I thought humility meant accepting the fact that I could be very well be wrong, and arrogance meant having a high conviction about your ideas regardless of what others are saying, especially when you are going against the crowd. My way of balancing the two sides of the coin was very childish – I knew I could be wrong so I would collect as much information as possible about the company I was researching on. This way I thought I was being humble, while at the same time justifying the arrogant act of buying a security because I thought I knew more than everyone else.
A few experiences have made me realize how inane my thinking was.
The first experience I had was related to a U.S.-based natural gas E&P company. I spent hundreds of hours of time researching this company. I spent so much time that I thought I was a natural gas expert in the end. I knew all the terminologies; I knew all the major plays in the U.S and I had all these statistics about natural gas production, consumption and historical gas prices. How could I not have an information edge to justify the arrogant act? I put together a spreadsheet that had all the data and it looked like I was getting a bargain. Of course, the shares of the company collapsed after I bought it along with the price of natural gas, which was the most important but unknowable factor.
Soon after I learned another lesson. This time it was a small cap company operating in a niche market. They had fantastic margins, the management team was able to allocate capital intelligently and it had created a tremendous amount of value over the years. The stock collapsed due to a bad quarterly miss on revenues and earnings, which threw off some institutional investors. Again, I spent a lot of time researching the company but having had the experience with the E&P company, I was more cautious and assigned a higher likelihood that my analysis was wrong. Furthermore, the selling was so atrocious that I thought there must have been something going on. By putting too much emphasis on the humility side, I passed on this company, which continued to post strong performance. I could have a multi-bagger, had I bought it.
Once I had a couple of experiences like these, I could relate to Klarman’s wisdom more and more by realizing a few things:
1. Collecting first level information will add absolutely nothing to my edge. Processing first level information with a first level mindset is useless at best and harmful at worst.
2. A better definition of humility than admitting the possibility of being wrong is staying within my circle of competency and knowing what I don’t know and what’s unknowable.
3. For me to act arrogantly, I have to have better information; think differently and better; and act more rationally by intensely curbing human psychological biases. When I can check all three boxes, I should act big. Otherwise I should be inactive.
Of course, Warren Buffett and Charlie Munger are my role models when it comes to balancing humility and arrogance. I’m amazed by how often they acknowledge that they don’t know enough to have an opinion (price of gold, oil etc). But within their circle of competency, they certainly act with ultimate arrogance (BYD, IBM, etc).
Undeserved arrogance and lack of proper humility is a perilous combination that can easily do investors in. It’s better to err on the side of conservatism than to act on false arrogance. I have personally used the following still-evolving checklist to help myself to balance the two:
1. Is the business within my circle of competency? Is it subject to super-catastrophe risk?
2. What information have I collected? Is it public information that other investors can easily have access to? Or is it information that I acquired through diligent scuttlebutt or painstakingly digging through all filings and transcripts?
3. Are the most important factors that will make the business succeed or fail in the next few years knowable or controllable?
4. Have I read the other side of the argument yet? Especially from the short-sellers? Do I have evidence or disconfirming evidence to support either side?
5. What it is that I know that most other investors don’t know? What misconceptions about the companies exist?
6. If the answer to question 5 is “no,” do I have a longer holding period than others? Are there any psychological biases (such as panic selling) that make it harder for others to react rationally?
7. Have I asked the “so what”, and “then what” questions enough?
8. Do a pre-mortem on the investment thesis.
This checklist is annoying, I know. But going through this checklist makes it much easier for me to decide whether I should lean towards the humility or arrogance. It helps me to behave more rationally.
In a book called "Superforecasting," Professor Philip Teltock wrote: “The humility required for good judgment is not self doubt – the sense that you are untalented, unintelligent or unworthy. It is intellectual humility. It is a recognition that reality is profoundly complex, that seeing things clearly is a constant struggle, when it can be done at all, and that human judgment must therefore be riddled with mistakes.”
I think Munger would have applauded these words.
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