Compounding the important things in life using a system

I think one of the biggest mistakes we make in life is setting ourselves extremely difficult goals to achieve. Think of the Argentinean football team, Argentina needed to be the World Cup champion, anything different than that it is the end of the world (given the pressure fans and journalists put on the team). Well, having that mindset will only create a lot of disappointments, a constant pressure to perform and an inflow of excess cortisol in the body. In life, home- runs are located in the tails, being the World Cup Champion is located in the tails, buying and holding a multi-bagger is located in the tails.

No one better than Morgan Housel can explain what being in the tails means, this article helps illustrate that.

We can have a goal saying we need to create $100 million (long tail goal) in ten years (starting from $100k); so we will leverage, sell options without covering them, try to find extra basis points, do silly things, try to look for home runs. Consequently, we will fail to follow Munger’s advice of staying rational for a long period of time.

Outcomes in the tails can be positive (owning Amazon shares for the last 15 years) or negative (owning shares in Russia before the Bolsheviks arrived — all stocks went to zero). These outcomes can happen without doing silly things, Black Swans are real. If investors are actively looking for the next positive Black Swan (the next Amazon or Google) they set themselves up for a life of disappointment, just like the Argentinean fans. They reached the best sixteen in the world, but for them, only the cup mattered, they set a goal located in the tails and anything else was a failure.

The brain does not notice small changes, we do not notice when we are getting fat, or when the temperature is rising (we notice once is too hot or the jeans are too small), that is how the brain is wired. Compounding consistently for long periods of time has the same effect. Unfortunately, we rather say: I made 10x on this investment than I made 12% per year for two decades as our brains are wired to search for the biggest outcome we can see. Everything we do little by little that adds has a huge impact if it constantly compounds. If the home runs were not in the tails then life would be easier. We need to be exposed to long tail outcomes (i.e. do things), that is extremely important but not actively look for them (if I am aware of Black Swans then they are not Black Swans). But how can we get long tails/positive Black Swans without actively looking for them and not risking our survival when a negative Black Swan shows up? Because they will.

I think having goals is wrong particularly at investing. I rather have a system, within the system I have goals but goals are not what matters, the system is. I believe if I have a system multi-baggers will be found and held -emphasis added.

As Scott Adams wrote: “If we only set goals we will be in a state of continuous pre-success failure (at best) and permanent failure at worst if nothing works.” The brain needs dopamine, that is the chemical that makes us feel good when we are doing things and we find what we seek, a system will ensure we get our dopamine every day. “System people succeed every time they apply their system, in the sense that they did what they intended to do”.

“The goal people are fighting the feeling of discouragement at each turn. The system people are feeling good every time they apply their system”.

Let’s continue with Scott Adams for the definition of a system: “A system is something you do on a regular basis that increases your odds of happiness in the long run” (I add, this is happy chemicals in your brain and absence of too much cortisol). “If you do something every day it is a system otherwise it is a goal” . For semantic purposes: “GOALS are a reach-it and be done situation”.

How can we apply a system to investing? Let me explain my system, the one that works for me and fits my personality:

I want to compound capital at a high rate of return for a long period of time (decades), for that I know I need to find multi-baggers and I know I will make several mistakes. Probably the ratio is 50 mistakes for an investment that really works. Who knows. Do I have a goal to find a multi-bagger every year? Or do I set a specific return I should generate every year? No, no at all, I set a system that will help me find, identify and hold companies I think are exceptional when found but the focus is on increasing my skills and not saying: Let’s go today and find the next Amazon and be done.

I decided to use a system and that is it. I know that I need to look for companies, therefore on a daily basis I search for companies, speak with people smarter than me, go to forums, investment clubs, twitter and wherever I think I can find ideas. Also, I read daily about companies (annual reports, transcripts, competitors filings etc).

I know that the markets can have a drawdown of 50% at any point in time so I work with the tools I have, I do not leverage, I do not sell options. I reduce my fragility to aspects I can control, I do not sacrifice a good night of sleep for an extra basis point. Whatever comes that will make the markets tumble are outside my control and I do nothing about it nor I worry, my only hedge is how I behave and to have high quality companies in my portfolio.

I know I need to behave better at investing so every day I learn something about the brain, I read books/articles/watch videos about the brain and do exercises about what I learn, as I know that if I do not behave I will not generate any returns. I do this as I am aware that behaving well is the most important and difficult aspect of investing.

I need to increase my worldly knowledge so I read books about several disciplines history/physics/biology/different industries (every day), also try to travel and take history tours, speak with locals whenever possible.

I know that I am old enough that building new circuits in my brain takes longer than before so new ideas need to be repeated. I repeat a lot videos/books/statistical exercises about all sort of topics, so I do not forget and new knowledge gets wired. This can annoy some of my friends and I do not blame them.

I need to get better at understanding businesses from a manager standpoint so I help take care of our little business (my girlfriend is the boss) -the Yoga studio we own and believe me I learn something (every day).

This system helps me identify ideas and hold the ideas that work, and also helps me identify mistakes and get rid of them. Ultimately, what I am trying to achieve is to compound the important things in life (relationships, knowledge, and capital). In addition, it helps me be more tolerant of my mistakes (they are part of the system) and aware of luck and the role of it in my outcomes (it is huge by the way). I am also aware that I need to do things otherwise luck cannot find me and it makes me aware that whatever I know today probably will be obsolete tomorrow.

The system helps me knowing more about myself as time passes, and it helps me find ways that will make me behave better.

Having a system frees me of the goals mindset and puts me in a position that I feel dopamine every day doing what I do, while exposing me to long tails. A final thought, a system needs to constantly evolve and that evolution should be part of the system itself.