What makes a company great? This is the very question Jim Collins and a dedicated group of researchers set out to answer.

Contributed by Gaurav Dhume

If that question seems daunting, imaging creating the shortlist. To start, the team gathered companies who exhibited incredible stock growth. After 10.5 people years of thorough analysis, 2000 pages worth of interview transcripts with company executives, and weeks of rigorous debates within the team, the list was narrowed down to 11 companies: Abbott, Fannie Mae, Circuit City, Gillette, Kimberly-Clark, Kroger, Nucor, Philip Morris, Pitney Bowes, Walgreens, and Wells Fargo.

Few people attain greatness because it is so easy to settle for ‘good’.

So what secret sauce did these companies contain that drove their stock to be 6.9 times higher than than the general market? They even eventually found that each transformation can be attributed to a process of buildup followed by breakthrough broken into three broad segments: disciplined people, disciplined thought, and disciplined action. Within each of these are 2 key concepts, as shown in Figure 2 below.

Disciplined People:

Level 5 Leadership

Collins’ research found that the leaders of great companies shared one particular characteristic — the duality of extreme personal humility with intense professional will. Although many were never featured on a magazine, their ability to channel ambition into creating an institution with lasting success instead of using it to further personal egoistic goals is rare among business leaders, but was recognized in all the CEO’s of the 11 great companies identified in Collins’ research.

As the graph explains, Levels 1–4 exhibit many of the same qualities, while level 5 leaders embody all characteristics in the hierarchy. The primary difference between level 4 and level 5 leaders is the uncanny ability to attribute success to any factor besides themselves, while simultaneously taking full responsibility for any failures.

First Who… Then What

Through his research Collins’ found that all the CEO’s of the great companies knew the importance of beginning with ‘Who’ rather than ‘What’ when it came to igniting a transformation for their respective firms. By getting the right people on the bus and getting the wrong people off the bus, the executives were able to figure out how to drive it in the right direction. Knowing the importance of assembling an exemplary team is nothing new, but realizing the importance of doing it before coming up with a strategy is the crux of this section.

As Wells Fargo CEO Dick Cooley put it, “Injecting an endless stream of talent into the firm is how you build the future. If I’m not smart enough to see the changes that are coming, they will. And they’ll be flexible enough to deal with them.” This ideology is what enabled Wells Fargo to thrive during the deregulation of the 80’s while Bank of America struggled.

Disciplined Thought

Confront the Brutal Facts

In the 1970’s Kroger recognized consumers’ direction towards the superstore concept. Their competitor, A&P, chose to ignore the trends and lost sorely. The ability tackle harsh realities head on while maintaining absolute faith that one would emerge stronger at the end is called the Stockdale paradox, and is a vital component of success.

Collins’ advice to CEO’s is to tackle change with a four pronged approach:

1) Lead with questions, not answers: Exhibit the humility to listen more than you preach, in severe pursuit of the truth.

2) Engage in dialogue and debate, not coercion: Heated debate among the right people is healthy and often necessary.

3) Conduct autopsies without blame: Admittance and understanding of failure is key to success.

4) Build red-flag mechanisms: Turn information into information that cannot be ignored.

The Hedgehog Concept (Simplicity Within three Circles)

English philosopher Isaiah Berlin divided people into two categories: foxes and hedgehogs. Foxes pursue many objectives simultaneously, fail to create one unifying vision, and are thus often scattered and diffused. Hedgehogs on the other hand simplify every complexity into one unifying idea, and render everything unrelated, irrelevant. Collins extrapolates that the great businesses had hedgehog personalities — the an uncanny ability to focus on a singular overarching goal.

Through their research the team found that the companies based their strategies upon the intersection of the three ‘circles’:

1) What can you be the best in the world at?

2) What drives your economic engine?

3) What are you deeply passionate about?

Disciplined Action

Culture of Discipline

Now that the right people are on the bus, led by a Level 5 leader, it’s time to dig deep into disciplined action. Collins puts it this way:

Build a culture full of people who take disciplined action within the three circles, fanatically consistent with the Hedgehog Concept.

Collins stresses that discipline doesn’t mean tyranny in the office. It means that each person is dedicated to cutting away extra activities and driving ceaselessly towards to overall goal of the company. It’s time to buckle down.

Technology Accelerators

Technology is often as much of a curse as it is a boon for the growth of a company, as evidenced by the dot-com bubble at the turn of the millennium. Companies began selling shares to the public at sky- high valuations based on the premise that their technology would change everything, regardless of its ability to generate revenue. Many of these companies subsequently failed, and American markets suffered.

Those that were able to make the transition from good to great approached technological change very differently. They thought long and hard about how the technology could further their hedgehog concept, and only after reaching a consensus did they act. Walk, crawl, then run.

A classic example is Walgreens, a company that many investors believed to be a slow-moving giant in respect to the technological shift at the end of the millennium, a sentiment they expressed by sending the stock price tumbling down 40%. Unperturbed, executives debated about how the Internet would tie in to their convenience concept and how it could increase their primary economic indicator; cash flow per customer visit. After much deliberation they began to walk, creating a website and testing online prescription delivery, then they crawled, testing different strategies to enhance customer experience and perfect their delivery model, and then they finally ran, investing heavily in a sophisticated satellite system to link all of their stores together. By successfully harnessing technology the company was able to pioneer a new convenience store model and the stock price subsequently doubled within a year.

A link to the full book can be found here. The views expressed are, unless expressly stated, the views of the author or the brief writer, not Titans Of Investing as an organization.

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Good to Great was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

The Importance of Moods

In the film adaptation of Harry Potter and the Goblet of Fire, Hermione, a heroine whose emotional intelligence matches her dizzying intellect, laughs heartily when her emotionally-limited friend Ron comments, “One person can feel all that?” Hermione keenly observes that people have incredibly malleable moods throughout their lives. Could you count how many times your mood changes in a single day? You might wake up hopeful about the day and then quickly diminish into stress when you look at your calendar scribbles.

Larry Senn argues that it’s worth noticing the positive and negative nature of your moods. He calls this moving up and down the mood elevator. His book explains that those confident people who don’t seem to “sweat the small stuff” operate near the top floors of the mood elevator and are usually better parents, leaders, and lives.

But why is this important and can anything be done about the Mood Elevator’s volatility? While it is true that everyone experiences each level of the Mood Elevator at some point in life, controlling the levels on the Mood Elevator can be done if we can gain control of our thinking. It’s possible when we start to understand the nature of moods.

Where do moods come from?

We commonly believe that moods are the result of external circumstances, when really it’s a more complicated than that. While events bombard us, we must remember that we are still the thinker. We may go to bed depressed and wake up hopeful; nothing about our circumstance has changed, only our thoughts about that situation.

“Life is largely what we make of it through our thinking.”

-Senn

Keeping Perspective Makes Us More Creative

Does it surprise you that a study reported that people have the most new or creative ideas while they are in the shower? The relaxation allows our minds to become more clear and focused. When up the Mood Elevator, our minds have the complete range of capabilities from the basics of memory and processing up to the highest levels of insight and wisdom. Alternatively, we tend to have lower quality thoughts when we are late, rushed, or frustrated.

Emotional Intelligence Makes Us More Successful

A study was performed by Daniel Goleman, the author of Emotional Intelligence: Why It Can Matter More Than IQ, in which Harvard graduates from classes in the 1940s were followed into middle age to see who would be more successful. Not surprisingly, those with a higher emotional intelligence (EQ) had higher salaries, life satisfaction, friendships, and family. This is important since emotional intelligence is much easier to gain than IQ.

Senn argues that a higher EQ means a person spends more time on the top floors of the Mood Elevator. When confronted with relational issues, a person with a high EQ will remain patient. When his extremist uncle goes on a rant about the tax reforms, the man with a high EQ reacts with curiosity.

Controlling Your Ride

Now that we’ve established that operating on the top floors of the Mood Elevator can substantially increase your likelihood of success and happiness, we can dig deeper into achieving control over our elusive moods. Where do we start? The answer: look to your feelings as your guide.

The first step in managing mood states is knowing your mood state. To an extent, we create our own feelings about situations with our thoughts; so, using the Mood Elevator as a barometer, determine what levels your feelings reside on most. Are you most often below, above, or near the center of the scale?

It’s important to note that since we can usually justify our thoughts regardless of how unreasonable they are, this technique will provide you with an impartial estimate of where your thoughts generally lie on the Mood Elevator.

Stopping on the Right Floors

Just like a real elevator, the Mood Elevator has a stop which you can activate when you start to dip into low quality thinking. This stop is curiosity. It is right in the middle before we drop down into the lower mood states. Some may argue that curiosity is the most important level on the Mood Elevator because living life with more curiosity is a great way to avoid falling to the lower floors.

If you thought the paragraph was profound nonsense, you went to one of the most over-used lower levels of the Mood Elevator — judgment. Here is the corrected paragraph:

Just like our crazy uncle’s outbursts, when things do not fit the way we want them to, it is easier to make them wrong than to explore the unknown. This judgment is why so many people see what is wrong with something first rather than what is different or what they can learn from it. Too much judgment over curiosity is the cause of many divorces and strained relationships.

A Microsoft CEO once said, “There’s no chance that the iPhone is going to get any significant market share. No chance.” Quick judgement failed him.

Shifting Your Normal Mood

Senn uses an illustration about an old Cherokee telling his grandson about a conflict between two wolves, one good and one evil, that live inside people. The grandson asked the old Cherokee which of the wolves wins, and he replied, “The one you feed.”

Senn says we may not even know if we spend the majority of our day on low levels of the Mood Elevator. We can even believe we are being “realistic” but have actually developed a gloomy and pessimistic outlook on life. “Unhealthy normal” occurs when any lower-level mood state becomes so familiar that we do not notice it and it becomes the new norm.

Thankfully, Senn offers some simple solutions. The first is taking care of yourself through regular exercise, good sleep, and healthy food choices. American Journal of Psychiatric Health concluded, “Exercise improves mental health and well-being, reduces stress and anxiety and enhances cognitive functioning” (Senn 91). One of the biggest payoffs of regular exercise is increased energy and stamina. This directly correlates to staying up the Mood Elevator. Likewise, the food that we choose to eat can also help us improve our “ride.”

The second way to shift our set point on the Mood Elevator is the cultivation of a specific perspective: a gratitude perspective. Gratitude is an overriding emotion. It is almost impossible to be grateful and angry or depressed at the same time. Since gratitude is more about others than it is about us, it can also override lower mood states like self righteousness, envy, and depression. In everyone’s own unique Mood Elevator, gratitude is most likely near the top. Regardless of what is happening, at the very least we can be grateful for the miracle of life itself. A gratitude perspective allows us to step back and look at all that we do have.

On the Ride Up

While the previous two techniques help with longterm movements up the Mood Elevator, here are a few tips to help minimize the damage of low level encounters:

• Pattern Interruption — It is a way to let go of one train of thought and switch to another. Good sleep, speaking with a dear friend, positive self-talk all are all examples of a
• Separate Realities — Two people rarely have the exact same thoughts about a particular topic. This is why a husband and wife rarely agree on topics like ABC’s The Bachelor. Before we become angry with another person’s view, we can ask ourselves, “what makes them see it that way?”
• Fresh Starts — A fresh start includes having the ability to forgive someone for his or her transgressions and to move on. Forgiveness is the key to starting fresh and mending any relationship — even with yourself.
• Humor Perspective — That is why “sense of humor” is listed in the top half of the Mood Elevator. When life gets extreme and we become overwhelmed, we can choose to laugh or cry. Which one are you more inclined to do? Learning to laugh at the occasional absurdity of life can help us maintain access to the upper levels of wisdom and clearer thinking.
• Faith, Hope, and Optimism — Senn points out that one way to have hope is by having faith. Faith that there will be an answer, that you can handle it, and that it will somehow work out. Faith and hope are often linked because faith gives us hope, and hope creates possibilities and healthier thinking.

We have been given the gift and power of thought, along with the consciousness and the ability to experience feelings generated by these thoughts. It is through these gifts that we experience life. The key to understanding the role of thought is knowing that thought takes us up and down the Mood Elevator. By learning to control our thoughts, we can ride our Mood Elevator more effectively.

“Things turn out best for people who make the best of the way things turn out.”

–John Wooden

Up the Mood Elevator was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

There is little doubt that preparation does play a considerable role in life’s endeavors, but so do the effects of randomness — the difference is being able to recognize which is which. A “lucky fool” does not know which is which until it is too late.

IF YOU’RE SO RICH, WHY AREN’T YOU SO SMART?

How random is randomness exactly? Despite our position as the most intelligent species on the planet, we as a human race have not exactly handled randomness and uncertainty with the greatest of ease. It is no secret that we are an amazing species — we have trekked the Himalayas, sent men to the moon, and created countless scientific and technological wonders to our own benefit, but we still are notoriously bad with what we cannot directly control. We as people do not have to be smart to be wealthy, nor do we have to be wealthy to be smart, but how much can we chalk up to being lucky, or simply exploiting randomness?

There is little doubt that preparation does play a considerable role in life’s endeavors, but so do the effects of randomness — the difference is being able to recognize which is which. In Fooled By Randomness, author Nassim Nicolas Taleb explains in many small examples how randomness is inescapable, but can be harnessed so as to protect and perhaps provide gains for the cognizant investor. As Taleb puts it, “the best description of my lifelong business in the market is ‘skewed bets,’ that is, I try to benefit from rare events.”

NERO AND JOHN

The main example begins with the two extremes of the risk spectrum, typified in trader form and explained in painstaking detail. On one end lies Nero, an extremely risk-averse but intellectually curious statistician with PhDs in philosophy and statistics, and on the other — John, an Ivy-league MBA with sterling credentials but an insatiable appetite for high yields. Summary profiles of the two traders can be found below.

It does not take much imagination to deduce that these two neighbors do not run in the same social circles. While Nero values trading as an experience that he does not want taken away, John views trading as a means to a rich and happy end. Both are successful and lead interesting lives at their respective positions, but for some reason, Nero can’t help but feel as if he is performing poorly. Nero is clearly the more intelligent, the more resourceful, and the more refined individual — he even works out four times a week; but something still bugs him about his situation relative to John’s.

Nero tried to soothe his jealously by bringing psychology into the picture. He knows that more people prefer to make $70,000 when those around them are making $60,000 than make $80,000 when others around them are making $90,000, but that didn’t quite suffice. What about John’s risk? Of course Nero was taking much less risk and still doing quite well, but it was also easy to see how an appetite for risk could easily be transformed into a bright red Ferrari in John’s driveway. Nero was doing just fine at his position and had considerable assets to take care of himself and his family for years to come. After deliberating, Nero could find no rational explanation why he should feel inadequate compared to John, but no matter how sound the logic in human behavior, he still felt slighted. Was John merely lucky? Could he have been riding the rollercoaster of the market? Soon enough, Nero would receive his vindication.

BLOWING-UP

John’s gains quickly materialized into thin air during the summer of 1998. After one week, he had lost $600 million that belonged to his employer and $50 million of his personal investment, $36 million of which was in borrowed money. “As in a biblical cycle, it took seven years to make John a hero and just seven days to make him a failure.” His over-indulgence on risk had cost him his job, and his excessive leverage in his investments had cost him his savings. John typified what is known as the cross-sectional problem: “At a given time in the market the most successful traders are likely to be those that are best fit to the latest cycle.” John was the victim of external success, and he had no reason to attribute his personal success to something other than his own skill and insight. The successful trader was indeed a lucky fool, “and by definition lucky fools do not know that they belong to such a category.”

Every trader has the potential to “blowup,” loosely defined as “losing money when one does not believe that such a fact is possible at all.” John and Nero are no exceptions, but how they go about managing their hidden risk is completely different. John has been extremely profitable for years and is considered to be a great asset for his company, but in the end he was blindsided by the market, blown-up thanks to his appetite towards risk assets and dependence on historical information. In short, John was exposed to all sorts of risk in the event that his positions turned sour, something that the conservative Nero had nothing to worry about during John’s years of outperformance.

IS JOHN RUINED?

After hearing about the devastating blows to John‟s career and life, it would be logical for one to assume that John was in fact ruined. There was no question that he would not be able to sustain the lifestyle he had created for himself, and he certainly wouldn‟t be trading anytime soon. In reality, John‟s net worth was reduced to a paltry $1 million, a fraction of his original worth before the blow up. Still, John was not destitute and could certainly afford a reduced lifestyle for his family. He could no longer live in the same house or socialize in the same circles, but he could continue on and adapt to his new surroundings. John’s personal confidence was gone and he was filled with shame, but he wasn’t as ruined as he made it out to be.

John‟s net worth that he had accumulated for years went from $16 million to $1 million in a matter of days. However, his $1 million still put him in the top 99% of earners in the world and would make him the envy of any neighbor outside of the Hamptons. Would John have felt differently about his $1 million if he had spent the same amount of time earning it from below? There is a larger gap between $16 million and $1 million than there is between 0 and $1 million, but in absolute terms they are the same. As Taleb points out, “there is a difference between a wealth level reached from above and a wealth level reached from below.” John should feel lucky that he came out of the situation with such gains, but like John, we as humans are simply not built to accept all things in rational, absolute terms.

DENTISTRY ≠ TRADING

The next example offered by Taleb is the comparison between two distinctly unique professions, namely, trading and dentistry. Make no mistake; your dentist is rich, very rich indeed. Although traders are typically viewed as being higher earners in the short term, they are figuratively poor on the average of lives they could have led. The average of lives in this sense can conceptually be thought of as the many random variations that one’s life could take — a seemingly endless array. In contrast to trading, a dentist operates in an area that is safe, relatively well-known, and in constant demand. Over the average of lives a dentist can take, most of them will probably lead to steady financial gain. For every Nero, there exists 10 Johns, and all of them have to go to the dentist at one point.

Every investing record should be considered in light of other outcomes or combinations of outcomes. These outcomes can also be called “alternative histories,” outcomes that could have occurred just as easily as the one that materialized in actuality. Because the things that happened are a very small subset of what could have happened, the quality of a decision should not necessarily be tied to the outcome of it.

Extending the metaphor a little further and switching gears in the process, dentistry can also tell investors a great deal about how one perceives losses and gains in the market. Take for example a successful dentist who retires to Florida to play golf and actively manage his accumulated wealth. For the sake of the example, the dentist is a smart enough investor that he is expected to earn a return of 15% with 10% error rate per annum (volatility). In short, he has a 93% probability of success for any given year. Not a bad situation at all.

With the newfound time the dentist has in retirement, he is able to sit at his desk day after day and monitor his investments closely and almost instantaneously. Instead of playing golf or other hobbies the dentist enjoys, he spends more and more time in front of his monitor, watching the market activity and keeping an internal count of gains vs. losses. Every second, he has a 50.02% probability of observing success; every minute holds a probability of 50.17%, and every hour, 51.3%. Surely this cannot be, given that the dentist‟s investments are destined to produce better results than average? The fact is that the probability of success is relatively 50/50 given the narrow time horizon, and the dentist absorbs the ups and downs of every second. Furthermore, some psychologists estimate that the negative pang he feels with every loss is 2.5 times greater in magnitude than every positive one. The dentist’s internal balance of accounts is certainly not balanced.

Is the dentist living out a very happy retirement? Well, it depends. Holding other factors constant, the dentist will run an emotional deficit day after day; however, what happens when the time horizon increases? The table below measures the probability of success for the dentist‟s portfolio at different scales.

As one can see, the dentist would be better off receiving statements of his performance over longer time periods. Now a 54% probability of daily success could transform into a roughly 77% probability every quarter. The dentist should probably spend more time on golfing.

Taleb leaves the reader with three main takeaways in regards to our friend the dentist:

1. Over a short time increment, one observes the variability of the portfolio, not the returns.

2. Our emotions are not designed to understand the point.

3. When [he] sees an investor monitoring his portfolio with live prices on his Blackberry, he smiles and smiles. People who look too closely at randomness burn out.

BLACK SWANS AND INDUCTION

“Nowhere is the problem of induction more relevant than in the world of trading — and nowhere has it been as ignored!”

With the constant pressures to outperform the market, investors can often lose sight of how randomness plays a role in their decision-making, even after becoming veteran to the effects. Scottish philosopher David Hume summed up this phenomenon in biological terms as the black swan problem: “No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.” In other words, just because an observer doesn’t necessarily see something after repeated observations doesn’t mean that it doesn’t exist.

For evidence of this phenomenon, one needs to look no further than John’s prior demise at the account of a devastating yet random event. To conclude, Taleb simply states that “extreme empiricism, competitiveness, and an absence of logical structure to one’s inference can be a quite explosive combination.”

WHAT GOOD IS INDUCTION?

Even though induction can be a dangerous concept, it is absolutely essential to our daily operations. Naïve empiricism, as referenced in the black swan problem, is something that every investor should be aware of when gathering information, but too much skepticism can be unhealthy and downright debilitating. As we will see later in the book, skepticism has its own use for the intelligent investor.

Induction can be explained as “going from the plenty of particulars to the general,” a sort of mental abstraction that “is very handy, as the general takes much less room in one‟s memory than a collection of the particulars.” Much like heuristics, induction is what allows the human being to act upon information before it is complete, an ability to make key decisions based on good, but not perfect information. This uniquely human trait is something extremely valuable, but each investor must realize that induction and timeliness operate inversely of one another.

Perhaps the best protection against black swans is the aptly named stop loss. Unlike John, a wise trader would have a predetermined set of events that would prove his conjecture wrong and allow for it. Based on this determination, the wise investor would terminate his/her trade at the predetermined exit point and thus be largely protected against further losses. It comes as no surprise that the conservative Taleb rarely finds this practiced.

ERGODICITY, BUT STILL FOOLED

The rule of ergodicity states that, given enough time, the annoying effects of randomness will be eliminated. Originally created to explain the phenomenon of evolution in the field of biology, the same term can be applied to the world of finance and trading. Over the long-term, different environments for a particular species change and may become more or less habitable. External forces, predators, and food supply all play a part in the viability of a species and eventually can lead to their downfall. Such is the world of trading, where fund managers that were profitable in the past five years cannot be expected to continue their profitability in any future time period with certainty.

“Remember that nobody accepts randomness in his own success, only his failure,” states Taleb as he recalls a particular meeting with the head of a department of “great traders.” These traders had been extremely successful in the early nineties, and were at no loss at providing explanations as to how their skill and prowess had gotten them where they were. After the harsh winter of 1994, however, the rule of ergodicity finally caught up with the traders, and Taleb, many years later, “could hardly find any of them still trading.” They had gone the way of the dinosaurs, become extinct as a result of their changing environment.

DEVIATING FROM THE NORM

If randomness is expected to be corrected after a given period of time, is there a need to worry about it now, or even in the immediate future? In the case of trading, high-magnitude deviations from the norm are what can absolutely make or break companies and careers. There is no question that trading deals extensively with the short-term, but understanding trading in the context of market cycles and longer-term horizons is absolutely critical for the novice and veteran investor alike.

Without digressing into an argument about Efficient Markets, Taleb simply states that “in real life, the larger the deviation from the norm, the larger the probability of it coming from luck rather than skills,” which is in effect a regression to the mean.

BILL GATES, BIASES, AND BURIDAN’S DONKEY

The second half of Fooled by Randomness deals more with concise examples of cognitive biases and other representations of how the average investor is not purely rational. Some of the more salient examples are noted below:

The Sum of Zeros: A sum of zeros, even repeated a billion times, remains zero; likewise an accumulation of research and gains in complexity will lead to naught if there is no firm ground beneath it. Taleb emphasizes the need for a proper, well-tested benchmark, if one can actually be found. If an investor should find himself dealing in unknown territory, “in the absence of much additional information it is preferable to reserve one’s judgment. It is safer.”

Network Externalities: What do Bill Gates and typewriters have in common? They both enjoy the suboptimal effects of network externalities. People have consistently been shown to be reluctant to change from the inefficient layout of the traditional QWERTY keyboard, which was created to slow down typing so as to prevent ribbon jams. Similarly, Bill Gates‟ ground-breaking software has been criticized by many since its inception, but it continues to dominate well over 90% of all personal and corporate systems to date because of its early widespread adoption. What is the reason behind these irrational examples? As more people use a keyboard or Microsoft Windows, they become more valuable to each owner thanks to consistency. Over time, network externalities may not represent the most optimal solution, but they will have become so ingrained at that point that change is very difficult, if not impossible.

Buridan’s Donkey: How do we as human beings break internal stalemates? Because we are not purely rational, we tend to embrace linear relationships: if you study more, you will be more successful on the exam. “Our brain is not cut out for nonlinearities,” says Taleb, who cites the famous example of Buridan‟s donkey that is equally hungry and thirsty and placed at exactly equal distance between sources of food and water. “In such a framework, [the donkey] would die of both thirst and hunger as he would be unable to decide,” but with any randomness injected into the situation, the result will be a well-fed, then well-hydrated donkey — or vice versa.

The Firehouse Effect: Veteran trader Marty O’Connell observed that firemen with much downtime who talk to each other for too long come to agree on many things that an outside, impartial observer would find ludicrous. Next, consider the group of economists tasked with covering a particular geographic area or market. Put simply, like-minded individuals placed in relatively isolated situations can become too immersed in their work to the detriment of the organization as a whole.

Satisficing Tigers: “Consider that those who started theorizing upon seeing a tiger on whether the tiger was of this or that taxonomic variety, and the degree of danger it represented, ended up being eaten by it.” Heuristics are extremely important in decision-making, but also note that “we follow them not because they are the best but because they are useful and they save time and effort.” Thus, we satisfy and sacrifice (satisficing); we stop when we get to a near-satisfactory solution in exchange for the savings in time.

EMOTION IN DECISION MAKING

It should be clear by now that the human mind is much different than the rationality imposed on it in most situations. “Our minds are far more complicated than just a system of laws,” but we still are able to function relatively efficiently. In fact, most people would probably agree that the world has certainly benefited from our sub-optimal dealings. Now that some notable biases have been discussed, we turn our attention to why we have them in the first place and what effect they play on a more personal level.

Have you heard the popular phrase “we only use 10% of our brains at any given time,” at one point during your childhood years? Although false — our brains are fully activated around 100% of the time — there is still some interesting merit to the phrase. Think about how hard our brains work every day and compare that with the deluge of information we are subjected to during the same time period. Regardless of how hard we think, we cannot utilize all of that information in order to make useful decisions. The cause of our biases is quite simply that it is “the fact that [our] mind cannot retain and use everything [we] know at once…one central aspect to a heuristic is that it is blind to reasoning.” This has also been supported by medical science, as exhibited by the famous case of a patient who could not register emotions. After a tumor and its surrounding brain tissue had been removed from the patient‟s skull, scientists witnessed that the “purely unemotional man was incapable of making the simplest decision […] he would lie in bed all day, unable to make any decision.” We need emotions in our decision-making, even if it results in sub-optimization. We do use 100% of our brains, but we cannot fully utilize 100% of the information we receive.

HOW DO WE FEEL ABOUT CHANGE?

Relative change is a particularly interesting phenomenon, as referenced earlier with Nero and John. Most people are naturally resistant to change primarily because of their discomfort with the unknown. This can also be extrapolated to how individual traders view changes in the market, or how gamblers view fluctuations in their gains, or more likely, their losses.

Humans are more receptive to relative changes on a local scale than the same changes, or total, on a global one. You will be hard pressed to overhear people at a casino say: “My net worth will end up at $99,000 or $101,500 after this gamble,” but rather, “I will either lose $1,000 or win $1,500.” As John the high-yield trader so eloquently displayed, people are much more likely to focus on the changes in score rather than the scoreboard itself. As Taleb states, “the fact that the losses hurt more than the gains, and differently, makes your accumulated performance, that is, your total wealth, less relevant than the last change in it.”

Although Fooled by Randomness cites a plethora of heuristics that are fascinating to the reader, the main points can be summarized in the table below. As a veteran trader, Taleb has associated some common labels rooted in trader vernacular to their appropriate scientific terms.

INDEPENDENT SKEPTICISM

Given all of the different theories, biases, and studies, it can be understandable for an intelligent observer to become quite skeptical. Contrast this with the naïve investor’s predilection towards extreme empiricism, and it begins to seem as if Fooled By Randomness is a practice in contradiction. Overall, skepticism is healthy in moderation, and it can come in quite handy when faced with too-good-to-be-true situations. Furthermore, Taleb suggests to the reader that skepticism should be embraced and utilized in the realm of trading, although in moderate doses.

The most famous example of skepticism, albeit extreme, comes from ancient Rome, where the philosopher Carneades argued to the Roman Senate both in favor and in opposition to the same point on justice. Carneades had so eloquently fought for the rights of justice and its effect on human motivation only to completely tear his previous argument apart the very next day. Simply put, this level of skepticism is not something one would expect to see in a Congressional assembly, sadly enough. The main point is that Carneades took no immovable position on any point and never committed himself to something he argued on behalf of. What changed Carneades mind we will never know, but he certainly didn’t feel obligated to explain it. Like the perfect investor, Carneades actions were independent of one another. The Roman philosopher had become, “totally free from [his] past actions. Every day [had become] a new slate.” All intelligent investors should seek to inject a little bit of Carneades in their everyday lives.

WITTGENSTEIN’S RULER

On a more personal note for the author, skepticism also helped to keep Taleb from over- analyzing feedback on his own literary works. Too often would he be tempted to pull up Amazon reviews, lamenting over the scores of people that disagreed with his books. He quickly noticed that the majority of the remarks aimed toward his work were more reflective of the reader than the information itself. He termed this Wittgenstein’s Ruler: “Unless you have confidence in the ruler‟s reliability, if you use a ruler to measure a table you may also be using the table to measure the ruler.” The salient point is that not everything can be used as a reliable benchmark, especially when little is known about the so-called benchmark to begin with. Given the surplus of ratios, formulas, analyses, and models that circulate around Wall Street, it is often difficult to differentiate the table from the ruler. As previously mentioned, whenever an appropriate benchmark cannot be found, it is probably safer to withhold judgment rather than jump to a conclusion.

Our physical and emotional make-up has made us a truly unique species, but we are obviously not without our faults. Although Taleb does not state it explicitly, the reader can implicitly conclude that in most situations, “common sense goes a long way.”

WE’RE ALL IDIOTS

As the examples come to a close, the author reveals to the reader his company’s philosophy towards trading and the markets. Every meeting at his boutique is started “by convincing everyone that we are a bunch of idiots who know nothing and are mistake-prone, but happen to be endowed with the rare privilege of knowing it.” The effects of randomness are so pervasive and insurmountable that they cannot be avoided, but for those who are intelligent enough to become aware, the nasty effects of randomness can be greatly mitigated.

We should again be reminded that there is a great difference between randomness and skill in the market. In the same vein, we should also know “that there is a difference between noise and signal, and that noise needs to be ignored while a signal needs to be taken seriously.” All of this seems much easier said than done, but steady rewards can come to those that don’t buy-in to the latest trend or contribute to the next speculative bubble. Regardless of the amount of calculation or science applied to the problem, history will tend to repeat itself. After all, “it is said that science evolves from funeral to funeral.”

Taleb spent a great deal of time trying to explain the effects of randomness and how we as investors and traders can better understand it, and he has developed no perfect equation or formula to negate the effects. There is also no spending threshold that will ensure us against the unknowable. Simply put, the best way to go toe-to-toe with randomness is to know it and study it. Although sports teams practice every week for a different team (the strategy), they must still be prepared to play in the big game on Saturday (the tactics).

In addition, Taleb also leaves the reader with some unsolicited advice:

• Dress your best on your execution day
• Try not to play victim when diagnosed with cancer
• Be extremely courteous to your assistant when you lose money
• Try not to blame others for your fate, even if they deserve blame

AND WHAT BECAME OF NERO?

With Nero’s continual success came increasing complexity. He had been required to travel more often to meet up with individual clients, and London had become his second home. In fact, he was spending almost more time in London traffic than he was in front of his clients, and he became more frustrated by the day. Although Nero was never the indulgent type, he did allow himself one occasional excess from time to time. He had enrolled himself in a helicopter training course, became licensed, and purchased a modest machine that would allow him to cut down on his travel time significantly. However, “Nero’s excessive probability-consciousness in his profession somehow did not register fully into his treatment of physical risk. For Nero‟s helicopter crashed as he was landing it near Battersea Park on a windy day. He was alone in it. In the end the black swan got its man.”

A link to the full book can be found here. The views expressed are, unless expressly stated, the views of the author or the brief writer, not Titans Of Investing as an organization.

Today’s Titans Brief was written by Preston Webb.

Randomness was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

They start with the basic theory that the way options are presented has a tremendous effect on the likelihood of different choices being made. By deliberately altering this presentation, policymakers can “nudge” people into making better choices than they might make if left to their own devices.

Consider this. A friend of yours is a director of food services for a large school system, and he knows that by simply rearranging the order and layout of the cafeteria, the consumption of many items fluctuates by as much as 25%. Given his options as the choice architect, wouldn’t his best option be arranging the food to make the students best off and healthiest?

This example highlights what Thaler calls “libertarian paternalism.” The paternalism comes from the belief that it is appropriate to influence people’s behavior in a way that makes them better off. It’s libertarian, however, in that choices aren’t taken away — they don’t propose mandates or bans — they are merely reframed.

Classical economic theory assumes that humans are rational decision makers who, when faced with a set of options, will calculate which choice maximizes their utility. This textbook view of human behavior may be appropriate in economic models, but is not an accurate portrayal of how humans behave in real life. People are not Homo economicus; they are Homo sapiens. We are subject to a myriad of fallacies, biases, and misconceptions that lead to sub-optimal choices in many areas of life.

Much of what causes humans to stray from purely rational decision making stems from the fact that we have two modes of thinking. This is covered in great detail in Daniel Kahneman’s Thinking, Fast and Slow, in which he proposes that the mind consists of System 1, which operates automatically and with little effort, and System 2, which requires effortful attention and can make more complex calculations. Thaler and Sunstein call them the Automatic System and the Reflective System, but the idea is the same. We make bad choices when our Automatic System hijacks the decision making process, preventing us from thinking it through rationally and completely.

“First, never underestimate the power of inertia. Second, that power can be harnessed.”

- Richard Thaler

This is manifested in a series of universal cognitive biases, some more well-known than others. One common example is the availability heuristic — we are more likely to overestimate the probability of an event if there are readily available examples of it occurring. Media coverage of plane crashes, for example, make us think they are more common than they actually are. Another bias is overconfidence — people are unreasonably optimistic about their own circumstances, even in the face of statistics to the contrary. Unfortunately, we rarely believe that the 50% divorce rate will apply to our nuptials. Finally, a couple that are particularly accessible to being fixed through nudges are framing and temptation. Framing refers to the way information is presented — think “90 of 100 survive” vs. “10 of 100 die” — that affects the way our Automatic System perceives a fact. Temptation is the result of conflicts between the Automatic and Reflective systems in the moment vs. in the future, or more intuitively conflicts between the Planner and the Doer. It’s easy for the Planner to decide to go on a diet, but when given a cookie, the Doer can’t help but give in.

Nudges are meant to give the Planner a fighting chance. A particularly useful example is with retirement planning. Currently, 30% of employees with employer-matched 401(k) benefits fail to enroll. If employees are automatically enrolled in a 401(k) plan — but importantly, given the ability to opt out — they are more likely to save. They are “nudged” into doing what should be rational, but what our irrational sides prevent. Another example is organ donation. When people have to opt in to becoming an organ donor, they usually don’t — even if they profess a more abstract belief in organ donation in general. By switching to an “opt-out” program, people keep their freedom of choice, but are nudged toward the one that saves more lives.

The proposals in Nudge seem reasonable and worthwhile, but are not without downsides. No matter how well-thought out a policy is, there are always unintended consequences. The idea of even well-meaning government bureaucrats tampering with people’s behavior may strike some as Orwellian, and it is in fact true that over the course of history, attempts to engineer a “perfect” society of citizens have led to tragic ends. The libertarian half of “libertarian paternalism” seems to mitigate this concern, but lines can be blurry about when nudges have gone too far. Another concern is that nudges remove peoples’ agency and personal responsibility for their own decisions, and in the process de-emphasize traditional notions of morality. If a person’s decisions are so easily manipulated, how can anyone be held accountable for their actions?

Despite these concerns, Nudge remains an insightful look into how we as humans make decisions and provides a framework for setting up institutions in such a way that can help maximize our long-term well-being. If implemented responsibly, Thaler and Sunstein’s proposals can go a long way in improving the lot of our amazing, if somewhat irrational, species.

This classic brief was originally written by Nick Bezner.

A link to the full book can be found here. The views expressed are, unless expressly stated, the views of the author or the brief writer, not Titans Of Investing as an organization.

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In Nudge: Improving Decisions About Health, Wealth, and Happiness, Professors Richard H. was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

It is easier to copy what is known than to create something new. Adding more of something familiar takes technology from 1 to n. In Zero to One, Peter Thiel conveys the lessons he believes are critical to building companies that create new things.

Peter Thiel, cofounder of PayPal and Palantir, wrote Zero to One based on a
course he taught at Stanford University. He taught this course to help his students “see beyond the tracks laid down by academic specialties to the broader future that is theirs to create.” In Zero to One, Peter Thiel conveys the lessons he believes are critical to building companies that create new things.

“Every moment in business happens only once”

The next innovative icon will not be a copy of Bill Gates, Larry Page, or Mark
Zuckerberg. So why do people copy their models? It is easier to copy what is known than to create something new. Adding more of something familiar takes technology from 1 to n. Creating something new takes technology from 0 to 1. “The act of creation is singular, as is the moment of creation, and the result is something fresh and strange.”

The Pattern for Success

Zero to One does not provide a formula for success, nor does one exist. A
concrete formula cannot exist because every innovation is new and unique. While Thiel does not provide a formula for success, he does identify a powerful pattern: “successful people find value in unexpected places, and they do this by thinking about business from first principles instead of formulas.”

The Contrarian Question

During interviews, Peter Thiel asks interviewees the following question: “What important truth do very few people agree with you on?” He asks this contrarian question because it relates to the future — as he puts it, the set of moments to come. We cannot predict the future, but we know that it will be different from today. Good answers to this contrarian question are the closest we can come to predicting the future.

The future should be defined by progress. There are two types of progress: horizontal and vertical. Horizontal progress involves spreading ideas and technologies that work; moving from one to n. Vertical progress involves creating new ideas and technologies; moving from zero to one. An example of horizontal progress is taking a typewriter, and building 100 more. Building a word processor for a typewriter, on the other hand, exemplifies vertical progress. On a macro level, horizontal progress is globalization, and vertical progress is the development of new technology. Since globalization and technology are separate types of progress, they can happen simultaneously, individually, or not at all. The future should be characterized by technology, not globalization because without technology limited resources will hinder globalization.

Thinking Clearly

Since the contrarian question is difficult to answer, start by asking: “What does everybody agree on?” This preliminary question identifies a false, conventional belief, and uncovers the contrarian truth behind it. When a conventional belief is disproven, the old belief is called a bubble. Unfortunately, bubbles are only disproven in hindsight. For that reason, “the first step to thinking clearly is to question what we think we know about the past.”

Thiel uses the dot-com crash as an example of questioning ideas about the past. The dot-com crash taught Silicon Valley entrepreneurs four lessons that still influence today’s business thinking: 1) “make incremental advances;” 2) “stay lean and flexible;” 3) “improve on the competition;” and 4) “focus on product, not sales.” These lessons are conventional beliefs among startup companies. However, the opposite lessons are more accurate: 1) “it is better to risk boldness than triviality;” 2) “a bad plan is better than no plan;” 3) “competitive markets destroy profits;” 4) “sales matters just as much as product.” According to Thiel, asking, “how much of what you know about business is shaped by mistaken reactions to past mistakes?” facilitates independent thinking.

Secrets

Contrarian thinking is senseless in a fully understood world. Fortunately, the world is not fully understood. We know this because there are concepts that are difficult and others that are impossible to understand. It is important to make the distinction between difficult things, which are achievable, and impossible things, which are not. Thiel describes a secret as “something important and unknown, something hard to do but doable.”

Most individuals act like there are not any secrets remaining in the world. Thiel provides one physical reason and four social reasons for this belief. The physical reason is geography. Our maps do not have blank spaces anymore. This makes the unknown appear more inaccessible than ever before. The social reasons are incrementalism, risk aversion, complacency, and “flatness.” Incrementalism states that the right way to do something is to proceed step by step to accomplish a task. Risk aversion is the fear of being wrong. Complacency prevents people from finding new secrets, because they are satisfied with what currently exists. Lastly, globalization causes “flatness.” The world is now seen as one competitive marketplace. This view causes people to doubt themselves and their ability to contribute to such a big world.

Finding secrets requires searching in places where no one else looks. The two types of secrets to look for are natural secrets and people secrets. Natural secrets are found by studying the physical aspects of the undiscovered world. People secrets are things that go unnoticed by the people that do them, or things that people hide from others. There are two questions to ask when trying to decide what type of company to build: “What secrets is nature not telling you?” and “What secrets are people not telling you?” There are many secrets waiting to be discovered, but finding them will require relentless effort from the searchers.

If someone finds a secret, they should treat it as such. Only tell those who need to know, and no one else.

A Startup’s Most Important Strength

Startup companies create most new technologies. Their small size and use of teamwork gives them an advantage over big organizations and lone geniuses. The reasons are big organizations move slowly and avoid risk, while lone geniuses cannot build entire industries alone. Thiel defines a startup as “the largest group of people you can convince of a plan to build a different future.” A startup’s most powerful asset is new thinking because it has to question the ideas it receives and rethink its business from the ground up.

Monopoly

Valuable companies capture some of the value they create. Thiel uses two economic models, perfect competition and monopoly, to illustrate this create-and-capture value concept. Under perfect competition, all firms are undifferentiated and sell identical products at prices determined by the market. Long run participation results in no companies earning an economic profit. The opposing economic model is a monopoly.

A monopoly is a company that performs at a level unmatched by other firms. Thiel believes, “if you want to create and capture lasting value, don’t build an undifferentiated commodity business.” From the outside, all businesses can look relatively similar. As a result, people only see small differences between companies. While people perceive firms as similar, in reality there are substantial differences. This difference between perception and reality is a result of firms describing market conditions in self-seeking ways. Monopolists protect themselves by overstating their competition’s power. This exaggeration allows them to conceal their monopolies and continue earning monopoly profits. Monopolists define their markets as the union of various large markets. Non-monopolists play down their competition. They attempt to distinguish themselves by describing their markets as the intersection of several smaller markets.

Luck or Skill

Is the future a product of chance, or design? The future can take on four different characteristics: definite, indefinite, optimistic, and pessimistic. If the future is definite, it can be understood and shaped. People with definite attitudes find the one thing they do best and strive to be great at it. If the future is indefinite, it is characterized by randomness, and therefore it cannot be mastered. For people with indefinite attitudes, “Process trumps substance.” When people do not have a plan for the future, they pursue various options to become well rounded. Americans take on an indefinite attitude towards the future. In addition, the characteristics of the future include optimism and pessimism. These can be defined as welcoming the future and fearing the future, respectively. These characteristics used to describe the future are combined to create four views: indefinite pessimism, definite pessimism, definite optimism, and indefinite optimism.

“Stagnation or Singularity?”

Singularity is the result of new technologies powerful enough to surpass the limits of current understanding. People must find singular ways to invent new ideas and technologies making the future both different and better. The first step is to think independently. Independent thinking allows people to see the world anew, making it possible to both re-create and preserve the world for the future.

A link to the full book can be found here. The views expressed are the views of the author or the brief writer, not Titans Of Investing as an organization.

Today’s Titans Brief was written by Ryan Pulido.

Zero To One was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

Folsom found that these key Americans are painted red — cruel, monopoly builders with a zest for poor working conditions and stuffing their pockets. He suggests that there are two sides to every story and begs you listen to the other side of the tale.

As a point of context, it is important to know that Folsom does not deny the presence of corrupt leaders during this period of growth. Instead of idolizing or condemning the whole group, he splits these businessmen into two groups: the political entrepreneurs, the Robber Barons who stifled productivity through monopoly and corruption and dulled competitive edge with politics, and the market entrepreneurs, those men who truly contributed to economic development.

So which story is the real story? I’ll leave that decision to you.

Commodore Vanderbilt and the Steamship Industry

It’s common knowledge that the first steamboat to roam New York waters in the early 1800s was built and operated by a man named Robert Fulton. It’s less widely known, however, that Fulton’s Clermont and fleet were kept afloat by a government-enforced monopoly, which allowed him to control all steamboat traffic in New York for thirty years. This thirty-year monopoly became the obsession of New Jersey businessman, Thomas Gibbons, and in 1817, he hired the young Cornelius Vanderbilt to help with his risky task.

Vanderbilt hoisted a flag up on the mast of Gibbon’s ship that read, “New Jersey must be free” and began sailing passengers from Elizabeth, New Jersey to New York City illegally for sixty days. In 1824, the Gibbons vs. Ogden case finally brought the Fulton monopoly to an end. New Yorkers were so thrilled that they launched two boats named for John Marshall, the Chief Justice of the Supreme Court who ruled against Fulton’s monopoly.

After the case, innovation flooded the industry. While Gibbons and Vanderbilt enjoyed efficient new tubular boilers and fuel, Fulton’s group ignored change and went bankrupt.

With two new ships of his own, Vanderbilt began his solo career by pushing rates to $1 and providing free meals to passengers. Vanderbilt remarked,

“If I could not run a steamboat alongside another man and do it as well as he for twenty percent less than it cost him I would leave the ship.”

Vanderbilt’s effect on the market was best described in a Harper’s Weekly article which read, “Wherever Vanderbilt laid on an opposition line, the fares were instantly reduced; and however the contestant terminated… the fares were never again raised to the old standards.”

As technology grew to support transatlantic steamships, a race for government subsidy began. Edward K. Collins pleaded with Congress for $3million a year plus yearly-added bonuses to build five ships with the ability to outrun the British fleet. Congress agreed to $1 million, but, unfortunately, Collins did not build the five efficient, speedy ships. He built slow, leaky, yet lavish ships… the world’s first floating resort.

By 1855, the ever-efficient Vanderbilt was appalled by Collin’s luxurious fleet. Vanderbilt knew that competing without funding would be nearly impossible, so he asked Congress to share Collins’s stipend with him, and in return, he would establish the cheapest transatlantic route in the world. Folsom humorously notes that Collins begged Vanderbilt not to ask Congress for a share in his funding, but the pleading on both sides was for naught; Congress denied Vanderbilt the subsidiary, but Vanderbilt decided to compete with his personal checkbook.

To stand a chance at beating Collins, Vanderbilt was forced to operate more efficiently than ever. In this crucible of necessity, he created the first 2nd and 3rd class. He built his ships with meticulous care, unlike Collins, who had to repair ships after almost every trip. Vanderbilt still barely scraped by. Reflecting on the first year he said,

“It is utterly impossible for an individual to stand in competition with a line drawing nearly one million dollars per annum from the national treasury.”

The winds changed after a head to head race between Collins’s ship and the new Vanderbilt; Congress finally saw how the “miserably managed” Collins lacked innovation and rebuked his subsidiary.

The New York Times once paralleled Vanderbilt to monopolistic German Barons, often called Robber Barons. The Robber Barons infamously demanded payment from passengers on their rivers, and no one could deny them or escape their control of the price. But after learning about Vanderbilt’s victory over political monopolies, Folsom argues that it becomes difficult to leave him in this category. Folsom says, “[Federal aid is] a curse, not a blessing, even to those who received it.”

James Hill and the Transcontinental Railroads

In the mid 1800s, the West was the final frontier of America. Think of it like the moon in the 1960s; reaching the moon was only possible because the government supported NASA with enormous funding. Similarly, in 1862, Congress passed the Pacific Railway Act, which had only one goal: to build a railway connecting the East to the West as quickly as possible, no matter the cost. To achieve this goal, Congress granted giant subsidiaries and additional loans to the Santa Fe, Union Pacific (UP). Central Pacific (CP), and the Northern Pacific (NP) railways.

The government’s agenda created a rushed schedule and conflicts that cost both dollars and lives. Would lay zig-zagged track to incur more aid and use cheap material. Thomas Durant, a UP official, once remarked to his manager, “You are doing too much masonry this year.”

When winter hit in Nebraska, the UP built right over the snow to keep on schedule. In spring they spent their resources rebuilding the ruined track. Lack of food and Native American attacks were common. As if fighting natives wasn’t enough bloodshed, the CP workers, who were primarily Chinese, and the UP workers, who were primarily Irish, began to attack each other over track disputes.

The problems continued to increase in complexity. A handful of UP stockholders created companies like Wyoming Coal and Mining and Credit Mobilier. Credit Mobilier worked like this: Mobilier charged high material prices to the UP, involved Politicians allowed subsidiaries to cover these costs, and the UP made a fine profit from their corruption. It was fine indeed for those involved until the scandal came to light. Congress had had enough.

It’s easy to blame these companies for their wrongdoings and forget that these are simply the effects of government monopolies. Wasn’t it said earlier that, like the moon, this achievement needed the support of the government? There is proof that the government was never needed; for while the CP and UP bickered over routes, a man named James J. Hill was building his transcontinental railroad without a penny from the federal coffer.

Though poor, Hill had the market entrepreneur spirit from the beginning. In 1838 he left his home in Ontario, Canada and boarded a train for St. Paul to begin his career. Hill dreamed about the Northwest as if it were the Promised Land of the Israelites. His journey there began in 1878 when he and a group of Canadian friends bought the bankrupt St. Paul and Pacific Railroad despite the critics’ scoffing.

Without government funding, Hill had to keep to a strict strategy. Hill spent time surveying the land himself. He built track slowly and primed his land before he went forward; he encouraged immigrants to farm near his land for $10, free cattle, and incentives like abundance awards and livestock contests. To these immigrants he’d say,

“You are now our children, but we are in the same boat with you, and we have got to prosper with you or we have got to be poor with you.”

Because he was obsessed with the straightest paths, lowest grades, and least curves, he hired a man to look for the lost Marias Pass — a legendary pass only whispered about in the journal of Lewis and Clark, which eventually cut his route by one hundred miles.

When Hill came to the Promised Land, the government-backed monopoly was there to meet him. Although he outlasted it, Hill resented the stall the encounter had on his progress:

“It really seems hard when we look back at what we have done in opening the country and carrying at the lowest rates, that we should be compelled to fight political adventurers who have never done anything but pose and draw a salary.”

But Hill didn’t stop when he saw the Pacific Ocean; he created an American wheat and cotton presence in the Oreint. Despite this achievement, The Hepburn Act, which required the publication and equality of all trade rates, almost forced Hill out of the Asian markets. President Roosevelt, the great enforcer of the Sherman Anti-Trust Act, which banned “every combination… in restraint of trade”, persuaded Congress to bust Hill’s corporation and holding company, the Northern Securities Company. Less efficient companies argued that Hill cheated them when he was simply acting as Vanderbilt had — using efficiency to produce the best product at the lowest cost. Folsom points out that without Hill, Americans would have relied on the railways which had inefficiencies literally built into them and they would have never gained the profit from the lucrative Oriental market. Much like Vanderbilt, he should be released from his Robber Baron category and seen as the economic developer that he was.

The Scranton’s and America’s First Iron Rails

The story of America’s independence from English iron and steel imports began when William Henry bought land in the Lackawanna Valley and solicited the support of the Scranton Group (Joseph, George, and Seldon Scranton); together, they hoped to create a great iron and steel manufacturing company. After several failed business ideas, the Scrantons decided to compete with English “T” rail market. Somehow they convinced the Erie Railroad to buy their rail “T”s over the English’s. It was their first great success.

Joseph Scranton stood out as a persevering figure. When he first came to Lackawanna Valley, Scranton said,

“I have no fears of the ultimate success.”

After his success with the Erie Railway, he began to build the city of Scranton around the factory. Immigrants, entrepreneurs, and dreamers flocked to Scranton to make their fortune.

And many did find their fortune. One man bought all the land he could and accumulated $10 million to leave his family after his death. Selden Scranton’s own uncle received the chance to start over at age forty. Innovators like Henry Boies patented a new train wheel and installed America’s first electric trolley system in Scranton. There was plenty of wealth to be created in Scranton.

The inheritors of this great wealth didn’t fair as well. George Scranton’s son was described as “leisurely”. The grandson who inherited the $10 million inheritance lived his life like an F. Scott Fitzgerald character, spending his money on his movie-star wife and trips to Paris.

From these contrasting examples, Folsom conclude that society needs market entrepreneurs to create wealth but that wealth creates leisure and stifles growth. He says,

“And so the cycle goes — which means that if Scranton is typical, then two seemingly contradictory generalizations about the rise of big business are both true. First, a small constantly changing group of entrepreneurs consistently held a large share of the nation’s wealth. Second, the poor didn’t get poorer and the rich didn’t get richer.”

Charles Schwab and the Steel Industry

A manager in one of Charles Schwab’s factories had done everything he could to get his men to work more efficiently. He yelled at them; he persuaded them nicely; he tried it all. After listening to the manager’s dilemma, Schwab walked out onto the production floor, took a stick of chalk in his hand, and chalked the day’s production number down on the floor in a giant curving “6”. The next day, whispers circulated that the big boss had observed them and chalked it. In the days following this incident, and much to the manager’s surprise, the chalked number began to increase: 7 then 10. What had Schwab done to inspire such an upswing in production? Nothing. Charles Schwab simply knew how to entice the competition out of his men.

It was during his time at Carnegie Steel that Schwab learned to be a ruthless businessmen but a kind leader. When Andrew Carnegie retired, Schwab became the president of this company but soon found that there was no room for employee incentives or innovation in the new owner, J. P. Morgan’s, plans.

Schwab left U.S. Steel and, without Carnegie’s guidance, began to drink, gamble, and have affairs. After wrecking his marriage and his relationship with Carnegie, Schwab decided to turn his energy towards a meager company he still owned called Bethlehem Steel.

At the time, Bethlehem Steel was worth just a fraction of U.S. Steel at $9 million, but he was determined to make it the best. Schwab began remodeling Bethlehem Steel by removing the stagnant partners and selecting his new team from workers on the shop floor. Soon his factories were thriving and had patented new, lighter-weight steel that changed the face of the industry. As a result, stocks grew from $20 to $600 per share.

Schwab also played a key role with the ship building in WWI. Franklin K. Lane implored the government to write Schwab a check and let him run the show. When Schwab took the job, he rearranged the faulty profit earnings, production, and the “cost-plus” system into a competition and incentive-driven workplace. He awarded flags and medals as well as bonuses out of his own pocket for outstanding ship builders. Ships were being produced ahead of schedule. After this success, Schwab tried to convince the government to cancel their plans to operate their own armory. They ignored him and suffered when the armory failed within four years.

Schwab is a figure whose personal blunders blind history from realizing his true impact on the American economy. It’s when he was given a chance to make a business great, that we see his brilliance and grit.

John D. Rockefeller and the Oil industry

Our next character was born to a peddler father and stay-at-home-mom with six children. He learned hard work from his father and enduring faith from his mother. Rockefeller said he was trained to work, save, and give from an early age. It was an unusual start for a near billionaire, but a fitting beginning for a man whose business motto was to provide the best product at the lowest price for the whole of his career.

One of his first partners, Maurice Clark, called Rockefeller methodical and detailed to an extreme. Clark said, “If there was a cent due a customer he wanted the customer to have it.” This love of honest business won Rockefeller many business friends. Folsom says this love was so intense that he even dreamed about business. Unrivaled though was his love for God and his family.

Rockefeller and Andrews, a fellow church member, joined forces in 1865 to tackle the rising oil industry. They decided to focus their efforts on refining oil in Cleveland, Ohio. Like Vanderbilt, Rockefeller skipped insurance costs by building quality equipment and winning shipping discounts from powers like Cornelius Vanderbilt himself.

After dabbling in the Southern Improvement Company, a pool of refiners who controlled oil rates, Rockefeller realized that a monopoly system wouldn’t work. Instead he turned to his innate market entrepreneurship once more and bought his own tracts of white oak timber, kilns to dry the lumber, and wagons and horses to haul the oak to Cleveland. Decisions like this allowed him to short the market price of $2.50 a barrel to just $.96 while still producing the best quality.

By 1870, Rockefeller had helped lower prices enough that reading and working became after-dark activities in America. Despite his positive influences, some people hated him. Oil businesses complained that he was forming a monopoly when he began to accumulate other companies, but Rockefeller said himself, “Competitors we must have, we must have.” Since the people were happy with cheap oil, he focused doing what he did best — producing quality oil at the cheapest price.

In the 1880s, many predicted Rockefeller’s downfall because electricity began to play a role in illuminating homes (no one knew the promise that gasoline would hold in the future with autos), the Russians started capturing a foreign market, and the Pennsylvania fields seemed to be drying up. Some senior members of Standard Oil even began to sell their stock.

Instead of selling parts of his company, Rockefeller continued to invest in an area that no one else would go near. The oil in Lima, Ohio was sulphuric and smelled horrible. A chief oil buyer at Standard Oil recalls that Rockefeller disregarded his negative advisors and collected nearly 40 million barrels of sulphurous oil.

After his labs figured out how to purify the oil, Rockefeller pulled out all the stops to meet the Russian challenge. Folsom says, “No small refinery would have had a chance; even a large vertically integrated company like Standard Oil was at a great disadvantage.”

Although Rockefeller may seem like a tyrant, his men loved him dearly. He gave ample praise and little rebuke. If his managers were overworked and tired, he would insist they take a leave of absence until they felt ready to work at full capacity again. He understood clearly that his people were the key to his success.

So how does a man who prioritizes life by God, family, and business end up with $900 million, making him the wealthiest man of his time? Folsom suggests that he truly applied his Christian practices to his work and life; this allowed him to worry less about failure and maintain humility in his success. He was often heard saying, “Early I learned to work and to play. I dropped the worry on the way. God was good to me every day.” He truly lived by these words and was said to be calm when the Sherman Anti-Trust Act came knocking on his door.

In his old age Rockefeller continued to give to the church. During his life, he willingly gave away about $550 million. Most remarkably, he would give the children in his neighborhood dimes, reminding them to work and save. This behavior seems drastically different from versions of his story, which condemn him to the Robber Baron category.

Andrew Mellon and the 1920s

We’ve come to Folsom’s final case he wishes to clear, and it’s worth mentioning that this is no easy task for this next figure. Andrew Mellon is probably the most misunderstood man in American history. Many people blame his tax reduction philosophy for causing the Great Depression when his reforms are actually the reason for American wealth in the 1920s.

Mellon was the grandson of a thrifty Scotch-Irish immigrant, who had come to America to escape the high taxes from the Napoleonic Wars, and the son of Thomas Mellon, a lawyer and avid tax critic. Thomas moved the family to Pittsburgh to practice law, start a bank, and raise his family. When Andrew came along, he was an eager learner when Thomas Mellon gave his children business lessons at the dinner table. Unlike his sociable brother Richard Mellon, Andrew’s demeanor was mouse-like. Someone once said, “When Andrew gave advice, ears strained to listen.” Thomas eventually retired as a proud father and turned his bank over to Richard and Andrew.

Although he was shy of rhetorical skills, Mellon was brilliant when it came to people and ideas. His eye for opportunities in technology and entrepreneurs helped him create Alcoa (Aluminum Company of America) when nobody knew where the future of the new metal was headed. Mellon exhibited this trait again when he spent $15 million of his family’s money to compete with Standard Oil in the south. His new company, Gulf Oil, went on to invent the first corner store and offshore drilling. By 1920, he was worth around $1 billion.

In 1920, President Harding was looking for a new Secretary Treasurer to revamp the stagnant post-WWI economy. It’s not a surprise that, with Mellon’s quiet disposition, he was not thrilled to receive the offer. The story goes that he traveled several hours by train to Harding’s home to speak with the President about the position. When Mellon arrived, there was a line of people waiting to see Harding. In typical Mellon fashion, he never marched past the others or requested to be seen at his appointed time. Instead, Mellon waited humbly in line for hours.

The current state of the government was the result of the Progressive Era (1890–1920), in which the income tax was passed. When WWI broke out, Congress used the income tax to pay for the war in Europe. At the time of his arrival, the top income tax group paid 77% in taxes. In the post-war era, people were becoming less willing to pay these astronomical rates. Woodrow Wilson later said, “There is a point at which in peace times high rates of income and profits taxes discourage energy and produce industrial stagnation with consequent unemployment and other… evils.” Americans were ready for change.

Mellon stumbled upon some vital facts during his study of the existing system. First, Mellon found that the longer the high taxes persisted, the lower household incomes became, which meant less revenue for the government. Second, he discovered that the top bracket was evading high taxes by investing in tax-exempt bonds, drying up the pool the government could tax. It was from these discoveries that he formulated The Mellon Plan, which consisted of four parts: to cut the top income tax rate to 25%, cut taxes on low incomes, reduce the federal estate tax, and promote efficiency in the government.

The plan was passed in 1926 when Coolidge became president; the table below shows how the taxes were redistributed. Notice that when Mellon cut the wealthy’s rates, the group took their money out of bonds and thus created a larger pool and more revenue for the government.

Despite the tax relief and increase in total government revenue, not everyone believed Mellon had the poor’s best interest in mind. College textbooks like American Pageant, The National Experience, and The American Nation still peg Mellon as the Secretary of the Treasury who “[placed] the burden of taxes on lower income groups” and gained from the reductions on the upper class. Few people understand that Mellon lowered the taxes on the poor proportionally more than he did for the wealthy. Finally, when considering his role in the Great Depression, it is important to remember that the periods of high taxes bookending the Mellon Plan, proved to be disastrous for the economy.

Entrepreneurs vs. Historians

Even after hearing these remarkable stories, Historians argue two points about these market entrepreneurs and their hand in the development of the American economy. The first argument is that these men were selfish monopolists. Folsom says, “In these views the cause and effect are clear: the rebates and unfair competition were the main causes of Rockefeller’s success; this success gave him an alleged monopoly; and the alleged monopoly created his fortune. Yet, as we have seen, Rockefeller’s astonishing efficiency was the main reason for his success. He didn’t get the largest rebates until he had the largest business.” These men were simply the best at what they did, and, like in Rockefeller’s triumph over the Russian oil companies in foreign markets, America would not be where it is today without their keen minds for big business.

Secondly, historians suggest that these individuals were mere pawns in the annals of history. That is, If they had not lived, someone else would have taken their place and America’s economy would be similar if not identical without them. To this point, Folsom wonders, why then did their competition not rise to great fame and fortune? It was the particular efficiency and savvy of these brilliant minds that created such wealth. He says, “What is missing are the builders who took the risks, overcame strong foreign competition, and pushed American industries to place of world leadership. These entrepreneurs are a major part of the story of American business.”

We’ve now come full circle, and I’ll pose the original question once again. What do you believe? After hearing the other side of the story, perhaps we can agree with Folsom that, though their reputations are highly disputed, these brilliant minds were key to developing the American economy into the dominant world power it is today.

The Myth of the Robber Barons was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

Sapiens: A Brief History of Humankind by Yuval Noah Harari is a condensation of human history into primary drivers and influential events. Harari avoids focusing on any specific group of people or events, but focuses rather on our species as a whole. Homo sapiens were once just one species among many under the genus homo. Harari tackles the question of what led Sapiens to become not only the dominant Homo species, but the dominant species throughout the planet. He breaks up the leaps that humankind underwent into four main movements: The Cognitive Revolution, The Agricultural Revolution, The Unification of Humankind, and the Scientific Revolution.

In the Cognitive Revolution, humans went from being another animal in the food chain to the apex species. This was driven by the ability to cooperate in large numbers because of the development of language and imagined creations such as states and religion that generated order. As we progressed forward during this time, other species were decimated in large numbers, including the other Homo species.

In the Agricultural Revolution, humans deviated from their roots by beginning to domesticate plants and animals rather than hunt and gather. The author argues that this movement was an immediate negative, rather than a positive for humans. There was less diet variety, more disease, and humans struggled with cultivation, which they were not biologically suited for. Harari states that the Agricultural Revolution supported more people, but under worse conditions. With food stores and populations increasing, there arose a need for order. Myths arose to sustain order, and the invention of writing contributed to our ability to organize and increase efficiency. Harari then points out that these myths such as religious hierarchies were neither fair nor just, and oftentimes led to deep-rooted discrimination.

In the Unification of Humankind, Sapiens became a more connected body driven largely by three main factors: money, imperialism, and religion. Money allowed men to cooperate despite religious differences or lack of personal trust. Imperialism linked large diverse population groups and merged cultures. Religion lent credibility to laws and organizations that claimed a divine source.In the Scientific Revolution, sapiens were able to make great progress through their admission of ignorance and quest to alleviate this ignorance. Furthermore, through the linking of science with capitalism and imperialism, science was able to garner funding for profit or power opportunities. The author then questions whether humans are happier now than we once were given our great progress. He rejects material gains as our primary source of happiness. Instead, he points to finding meaning in one’s life as a strong source of happiness throughout history, yet questions whether there is any validity in this search for meaning. Finally, Harari concludes by questioning whether the Sapiens species will come to an end in the future. However, he does not cite apocalyptic theories such as nuclear devastation as our cause for termination, but states that science itself has the potential to alter our species beyond recognition.

Many may not wholly agree with the author’s perspective on key subjects. Contrary to Harari’s view of humankind as nothing more than an evolved animal, there exists an opposing view that would view humans as significant. This significance stems not from any actions taken by the Sapiens themselves, but rather, from the source of life itself. There are those, myself included, who would claim that man is created in the image of God intended with the purpose of furthering His Glory. While it is true that throughout history men have created objects and stories, this is true because their creator is also a storyteller. The only difference is that His stories become history, while ours remain on pages and in our ever-fickle minds. Man understands what it means to love one another because we were first loved by The Creator. Men have sought for meaning and purpose in life, because there is in fact a meaning and purpose to their lives. We will constantly strive in vain for joy if we do not seek first the source of joy. A multitude of years have been spent by Sapiens in the search for this happiness. This can be seen in the progress we have made such as the Agricultural and Scientific Revolution that have been rooted in the hope for improvement and happiness. However, these quests for happiness lead to dead ends if sought in areas outside of that for which we truly crave and that which can only bring the joy for which we seek.

The author grapples with the question of whether we are happier as a species now than in the past. He does not offer an answer, but refutes multiple theories, leaving readers with no clear answer. Harari does make a valid point when he states that family and a purposeful life have historically been successful sources of happiness. From the perspective of the betterment of our species, we are clearly better now. The population is much larger and the standard of living is higher. However, from a happiness perspective, there is one source of happiness and it has not changed over the years. It is as unflagging and constant as time itself, because it precedes time. It is also independent of our collective actions. All meaning and happiness is derived from this source. I would claim this source to be my faith.

On the topic of order, it would appear that the strongest glue for laws and governments has been religion. The author questions whether any system is better than another objectively due to his view of all systems including religion and government as nothing more than creations of our imagination. However, I would argue that neither morals nor justice exist outside of some absolute upon which to base them. If one believes in such an absolute, then there does exist an objective definition of what is right and what is wrong, and this is what we should strive to follow.

A link to the full book can be found here. The views expressed are the views of the author or the brief writer, not Titans Of Investing as an organization.

Today’s Titans Brief was written by Blake Shirk.

Sapiens was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

In his 2011 work The Better Angels of Our Nature: Why Violence Has Declined, Harvard psychologist Steven Pinker reasons that, contrary to popular belief, the world has become less violent over time.

Pinker begins by reminding his reader of the violence of centuries past. Pre-historic societies, Biblical narratives, and Ancient Greece were filled with bloodshed, and torture was brutal and extremely common until just a few centuries ago.

He then identifies six trends that have led humans away from violence:

• The Pacification Process: In this movement, humans formed modern states, which led to a fivefold decrease in the rates of violent death.
• The Civilizing Process: This process occurred in Europe from the Middle Ages to the late 20th century when authority was consolidated and an infrastructure of commerce was established. The result was a ten-to-fiftyfold reduction in rates of homicide.
• The Humanitarian Revolution: This revolution began with the Age of Reason and the European Enlightenment and involved the first attempts to eliminate socially sanctioned forms of violence such as superstitious killings, slavery, and dueling.
• The Long Peace: Since the end of World War II, humanity has lived in a peaceful age in which most of the world’s developed states have stopped going to war.
• The New Peace: This era has seen a decrease in genocides, civil wars, despotism, and terrorist attacks throughout the world since the end of the Cold War. Four threats to the New Peace include a civilizational clash with Islam, nuclear terrorism, a nuclear Iran, and climate change, all of which are deemed unlikely to cause major harm. Pinker argues the chances of a major episode of violence erupting in the next decade (100,000 deaths in a year, or a million deaths overall) is less than 10%.
• The Rights Revolutions: The world has seen an explosion in the advent of rights for children, ethnic minorities, women, homosexuals, and animals since 1948.

After establishing the trend towards nonviolence, Pinker asserts that humans have forces that both push them towards violence and pull them away from it. He presents five Inner Demons that drive our violent tendencies:

• Predation: Predation involves violence in the deployment of means-end reasoning to achieve a desired goal.
• Dominance: The desire for glory, power, or authority can motivate individuals or large groups to inflict violence.
• Revenge: A leading motivator of homicide, revenge can lead to a moralistic search for justice, retribution, or deterrence of a rival.
• Sadism: Enjoyment of the suffering of others is an acquired taste and can arise from a variety of motives.
• Ideology: As a group pursues its shared idea of a greater good, violence can become a means to the end.

Better Angels of Our Nature in Graphs & Numbers

Pinker also enlists science to defy the notion that humans naturally tend toward aggression and must periodically release it; instead, there are many triggers for aggression.

Next are Four Better Angels that help humans move towards nonviolence:

• Empathy: Pinker believes empathy has been given too much credit for the reduction in violence. However, empathy often manifests itself as sympathy and taking the perspective of others, both of which have had a large influence in the humanitarian movements of the last centuries.
• Self-control: This trait has varied across time and culture, but it can regulate both violent and nonviolent impulses. It can also be strengthened on an individual level over time.
• Moral sense: Though misplaced morality has been a large contributor to violence, when morality is deployed in the correct manner, it can move us towards nonviolence.
• Reason: Pinker argues that reason is our greatest hope for reducing violence. It allows us to change vantage points, improve ourselves, and guide the use of the other angels.

Finally, Pinker summarizes the Five Historical Forces that have had the largest influence on the movement towards nonviolence and that will propel it further: a state with a monopoly on force (Leviathan), gentle commerce, feminization, cosmopolitanism, and the escalator of reason.

The decline in violence that Pinker presents helps the reader to see the relatively nonviolent present more clearly and affirms that efforts to reduce violence are worthwhile. Though it often seems dark, modernity has provided many movements and ideals that have led us to place a greater value on human life. Pinker believes that humanity is moving in a more peaceful direction and that, with the help of the Better Angels and increased humanitarianism, more peace can be achieved.

'The Better Angels of Our Nature'

A link to the full book can be found here. The views expressed are, unless expressly stated, the views of the author or the brief writer, not Titans Of Investing as an organization.

Today’s Titans Brief was written by Macy Hicks.

The Better Angels Of Our Nature was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

George Soros is well known among the financial elite as one of the most successful hedge fund managers in recent history. In October 2009, he began a series of lectures at Central European University that would explain his perceived conceptual framework as it relates to the behavior of people in the financial markets.

Lecture One: The Human Uncertainty Principle

As a student at the London School of Economics, Gorge Soros began philosophizing about his idea of behavior in the financial markets. His initial framework, influenced greatly by Karl Popper’s The Open Society and Its Enemies, was centered around an open society: a society in which people are free to hold divergent opinions and the rule of law allows people with different views and interests to live together in peace. This struck him as odd as he was concurrently learning economic theory. Karl Popper’s theories were based around abstracts and uncertain information; whereas, economic theory assumed perfect competition which postulates perfect knowledge. This perplexing idea, coupled with many life experiences brought Soros to the concepts that he would eventually model his investing principles after: fallibility and reflexivity.

From the archives: the open society and its enemies revisited

Fallibility is clearly defined by the fact that in any situation where there are thinking participants, the participants’ view of the world is always partial and distorted. Then, these distorted views can influence the situation to which they relate because false views lead to inappropriate action. That is reflexivity. For example: Treating drug addicts as criminals creates criminal behavior. This misconstrues the problem and interferes with the proper treatment of addicts. Fallibility is far less controversial than reflexivity. Almost everyone would agree that the world we live in is much more complex than we could comprehend.

Reflexivity can be broken down into two diverging sections. One, cognitive function, is the understanding of the world we live in. The second, the manipulative function, is how we change the situation to our advantage. Because each of these are happening at the same time, it robs each of the truly independent variable, or knowledge as Soros explains, we need to perceive the correct decision or action to take. This being the case, the two are linked subliminally. Consider this example: the statement “It is raining” is true or false based on whether or not it is truly raining. The statement “This is a revolutionary movement” is reflexive because its value depends on the revolution’s impact.

With reflexivity, any two or more aspects of reality can be connected with feedback loops, of which can be either positive or negative. Negative feedback loops bring the participants’ views and the actual situation closer together; whereas, positive feedback loops drives them further apart. In other words, negative feedback loops are self-correcting and positive feedback loops can go on forever. In this way, bubbles are created by a self-perpetuating positive feedback loop in which reality becomes so distorted that it must revert to a negative feedback.

Reflexivity is not the only source of confusion when dealing with the economic environment. There is also the imperfect knowledge and the inability of people to know what others are thinking at any given moment. This can be seen in economic theory. It started out assuming perfect knowledge, and when that assumption proved untenable it went through more contortions to maintain the fiction of rational behavior. This is how the theory of rational expectations came into existence. It was necessary to let economic theory model itself after Newtonian physics.

Lecture Two: Financial Markets

During this lecture, Soros applied the aforementioned framework to the financial markets. By the preceding definitions, Soros’ view of the financial markets violates the efficient market hypothesis. Firstly, market prices always distort the underlying fundamentals. Secondly, financial markets play an active role in affecting the fundamentals they are supposed to reflect. This is the diverging principle of Soros’ viewpoint and behavioral economics.

Bubbles, or boom-bust process can be explained simply under Soros’ philosophy: Ever bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. A boom-bust process is set in motion when a trend and misconception positively reinforce each other. The process is liable to be tested by negative feedback along the way. If the trend is strong enough, the misconception will be further reinforced.

Bubbles are not the only way that reflexivity is shown in the financial markets. For example, in the currency markets, the upside and downside are symmetrical so that there is no sign of an asymmetry between boom and bust, but there is no sign of equilibrium either. Freely floating exchange rates tend to move in large, multi-year waves.

Soros used this information to “pop” the super bubble of 2007. The housing bubble in the United States was the most common kind, distinguished only by the widespread use of CDOs and other synthetic instruments. Behind the ordinary bubble was a much larger super bubble growing over a larger period of time that was much more peculiar. The prevailing trend in this super bubble was the increasing use of credit and leverage. The administration at the time believed that the markets were efficient, and if left to their own devices, would correct to a mean. This not being the case, as Soros believes in his philosophy, he called the boom-bust process during the market crisis of both 1997–1998 and 2007–2008.

Because markets are bubble prone, Soros offers ways to regulate the economy. First, financial authorities must accept responsibility for preventing bubbles from growing too big. Second, in order to control asset bubbles, it is not enough to control the money supply; you must also control the availability of credit. Third, regulators cannot ignore market risk because too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or a collapse. Fourth, we must recognize that financial markets evolve in a one- directional, nonreversible manner. Finally, the drafters of the Basal accords made a mistake when they gave securities held by banks substantially lower risk ratings than regular loans, as this was an important factor in aggravating the crisis.

Lecture Three: Open Society

In this lecture, Soros describes the concept of open society. The connection between open society and reflexivity are far from obvious, but they are connected. Their connection, on a conceptual level, is fallibility. It is the definition of fallibility, our distorted view of reality, that often makes us misconstrue societies complexity. It is these misconceptions that inevitably shape our history thus creating reflexivity.

The enlightenment period, focused on seeking and finding truths, gave rise to the ideology of perfect knowledge: all knowledge is available and can be discovered. This led to what is called the Enlightenment fallacy. Soros draws a connection between that and what he calls a fertile fallacy, a fallacy based in truth. A fertile fallacy means that we are capable of acquiring knowledge, but we can never have enough knowledge to allow us to base all our decisions on knowledge.

There is a competing belief to the Enlightenment fallacy and that is called the post- modern worldview. This view is a pragmatic approach to politics. Basically it approaches politics in the following manner: Now that we have discovered that reality can be manipulated, why should the cognitive function be given precedence?

The event that forced Soros to thoroughly divulge into the concept of open society is the reelection of George W. Bush. He states, “Here was the oldest and most successful democracy in the world violating the principles for which it was supposed to stand by engaging in human rights violations in the name of fighting a war on terror and invading Iraq under false pretenses. Yet, he was reelected.” It was this event that led him to believe that our view of the world is deeply rooted in an intellectual tradition that either ignores the manipulative function or treats it as subservient to the cognitive function.

The manipulative techniques have developed over time. They originated in the commercial arena toward the end of the nineteenth century when entrepreneurs discovered that they could improve their profit margins by differentiating their products through branding and advertising. This led to manipulation in the demand curve by advertising, thus giving rise to the manipulative function.

Lecture Four: Capitalism Versus Open Society

In this lecture, Soros discusses the inherent dichotomy between capitalism and open society. The main point of contention is the agency problem. Markets are supposed to be guided by an invisible hand; that is what makes them efficient. In truth, the rules governing the financial markets are decided by the invisible hand of politicians, and in a representative democracy politicians run into an agency problem. This value is perpetuated by the inherent view of democracy and open society. The politician has to please the constituency in order to get reelected, regardless of their beliefs on how the markets, or regions should be governed. This in turn leads to reflexivity as values and social orders are highly subjective.

The only distinguishing feature of the market mechanism, as it relates to capitalism and open society, is that it is amoral; mean every person’s dollar is worth exactly the same as another person’s; irrespective of how she came to possess it.

Capitalism is not directly opposed to open society; nevertheless, it poses some serious threats. Firstly, markets are not equilibrium bound, but instead bubble-prone. Secondly, the agency problem of democracy separates the two beliefs. As a far extreme, lobbying is at the core of the agency problem in America and borders on an ethical dilemma.

Lecture Five: The Way Ahead

In this lecture, George Soros describes where he sees the economy going as it relates to the aforementioned topics. He states, “We are at a moment in history when the range of uncertainty is unusually wide.” He is unusually optimistic about the bailout attempt, but is calling for a double dip in either 2010 or 2011 as we are still in a far from equilibrium situation in the financial markets. To illustrate: Effectively, the international financial system has a two- tier structure: countries that can borrow in their own currency constitute the center, and those whose borrowings are denominated in one of the hard currencies constitute the periphery. If individual countries get into difficulties, the receive assistance, but only under strict conditions. That hold true whether they are from the center of from the periphery. But if the center itself becomes endangered, then preserving the system takes precedence over all other considerations. Thus, he supported and will continue to support a bailout through a double dip.

In addition, he sees the United States losing its seat as the sole super power financially. The likes of China and other emerging markets are seeing a faster rebound, which he believes will propel it to the top of the pack economically. But, with this globalization, Soros calls for greater financial regulation. Without this, he states, financial markets will not be able to remain global.

In summary, the world is facing a choice between two fundamentally different forms of economic organization, international capitalism and state capitalism. The former, represented by the US has failed with the financial crisis. The latter, represented by China, has only begun to grow and will see extensive growth in the near term.

A link to the full book can be found here. The views expressed are, unless expressly stated, the views of the author or the brief writer, not Titans Of Investing as an organization.

Today’s Titans Brief was written by Mark Gibson.

The Soros Lectures was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.

Through his work, Charles Duhigg strengthens the notion that humans are not creatures of choice, but rather servants of habitual tendencies. Using adaptive anecdotes and psychological evidence, he explains the steps necessary in building habits. Habits can possess a great degree of ‘promise or peril’ in our lives, and through understanding their build, we can alter or replace them to realize healthy outcomes. Duhigg concentrates on the influence of habits in three broad categories: the lives of individuals, the strategies of organizations, and the perpetuation of social movements.

The Habits of Individuals

As a result of evolution, our brains are capable of storing habits. To complete and activate these habits, the brain must utilize a process known as ‘chunking,’ through which it converts a sequence of actions into an automatic routine. We rely on hundreds of behavioral chunks every day, and understanding their pretense is key in controlling habits. Once chunks are activated, our grey matter is free to quiet itself, in our brains’ natural attempt to conserve mental energy. Neurological chucks are completed in a loop formation.

The habit loop consists of three, hallmark mechanisms: a cue, a routine, and a reward. As the loop is repeatedly employed, its cue and reward points become entwined, until a powerful sense of craving emerges. The most powerful step in forming or destroying a habit is to discover its loop construct. Conscious knowledge of the loop allows us to ignore, change, replace, and control habits. Habitual psychology is grounded in two basic obligations: find a simple and obvious cue, and clearly define the rewards offered. Although these foundational pieces are key, it is important to recognize neurological cravings as well, which emerge so gradually that we are often not even aware of their existence. In many non obvious ways, a simple want can evolve into a sense of craving that can move us in undesirable ways, even in the face of strong disincentives.

Duhigg describes tactics used by successful NFL coaches, illustrating the importance of players’ individual routines. In these situations, as well as in many others, the ‘Golden Rule’ of habit becomes crucially important: to change a habit, one must keep the original cue, and deliver the original reward, but insert a new routine to bridge the two.

5 Scientific Ways to Build Habits That Stick

The Habits of Organizations

To ensure organizational success, strategic leaders must understand the power of keystone habits, with which success is not dependent upon getting everything right, but rather on identifying a few key priorities and fashioning them into powerful levers. While keystone habits are central to organizational success, they are also applicable to the lives of individuals. Exercising, for example, is a keystone habit, as it has a ‘spillover effect’ in our lives (when we exercise, we are more likely to eat healthier, become more productive, show more patience, etc.). Companies employ keystone habits to ripple positive behaviors throughout their entire organizations. In tandem with these habits, organizations gain power through the realization of small wins. Through robust stories, Duhigg illustrates that organizations, which are able to realize initial series of small wins when completing a strategy, are perpetuated forward, realizing additional small wins.

Duhigg dissects the content underlying Starbuck’s employee curriculum, stressing its role in growing the business. Turning self-discipline into organizational habit, Starbucks teaches the life skills that schools, families, and communities have neglected to address. The company tactfully explains routines to follow when barista willpower grows tired, ensuring consistent customer service. Modern behavioral theory analogizes willpower to a muscle, which tires when stressed, and this analogy explains why otherwise successful people succumb to destructive activities.

Destructive organizational habits can be found within thousands of firms, and are typically the product of thoughtlessness. Firms seem to be guided by organizational habits, which emerge from thousands of employees’ independent decisions, rather than the deliberate decision-making performed at the c-suite level. When destructive events occur, organizational habits become malleable, allowing leaders to both assign responsibility and create an equitable balance of power.

The Habits of Movements

Social habits, which govern movements, are often hard to see emerge, but contain power that can change the world as we know it. They evolve over a three-part process to become self-propelling and reach critical capacity: first, a movement begins because of the social habits of friendships and the strong ties between close acquaintances. It then grows as a result of communities’ habits, and the weak ties that hold them together. A movement endures because its strategic leaders give participants new habits that create a fresh sense of self-identity and ownership.

Duhigg focuses on the factors that transformed the Montgomery Bus Boycott from a daylong arrest response, into a multi-year movement for race equality. Rosa Park’s arrest triggered a series of social habits, which were initiated through the protests of her closest friends. The power of weak ties then elevated the movement to unprecedented levels, spreading common emotions across communities and neighborhoods of people. Surprisingly enough, our weak-tie acquaintances are often more influential than our close-tie friends, and these ties help explain how protests are capable of expanding from small gatherings to broad, social movements.

To become a movement, protests must become self-propelling, a feat only possible if people are given new habits that help them figure out where to go and how to act on their own accord. The movement became self-propelling through the ‘embracing-oppression’ messages Martin Luther King disseminated. His concepts, which were imparted to the masses, cast the boycott in an entirely new light, in which people could show their allegiance by adopting the new habits King was evangelizing. When the opposition would act violently against peaceful, black protestors, the movement would gain additional momentum, followers, and coverage; in this way, the movement’s habits allowed it to power and propel itself forward.

About The Author

Duhigg wrote each chapter of The Power of Habit around a single, central argument: habits can be changed, if we understand how they work. Though his stories, he simplifies complex behavioral discoveries into chewable concepts, which we can utilize within our own lives to become stronger willed and more successful. Duhigg first became interested in the science of habits, as a news reporter in Baghdad. He describes the US Military as, “one of the biggest habit-formation experiments in history.” Inspired by modern cases in which habits are employed, Duhigg focuses his book on describing why habits emerge in the first place and how they can be better governed. He says, “Transforming a habit isn’t necessarily easy or quick. It isn’t always simple. But it is possible. And now we understand how.”

My Perspective

My hope is that this brief provides readers with fresh ideas about their own behaviors, and inspires them to take action to control their lives. The book has completely altered the ways in which I view my own behaviors, tendencies, and willpower; it has allowed me to understand the neurological cravings which rule over me. Not only have I gained a great deal of self-understanding, but I have also gained a sense of how to strategically lead with attention to habit.

The most fascinating portions of my brief, and the book for that matter, are those that illustrate habits playing roles in real world situations — situations we see every day as consumers, but have neglected to understand. I’ve been able to develop a curious awareness of habit, which is employed every time I walk into a Target or Starbucks, use Febreeze, brush my teeth, watch football, exercise, avoid binge-watching Netflix, etc. That’s how powerful these concepts are; they possess the ability to change our entire perspective on subconscious behavior.

A link to the full book can be found here. The views expressed are, unless expressly stated, the views of the author or the brief writer, not Titans Of Investing as an organization.

Today’s Titans Brief was written by Jonathan Bokemeyer.

The Power Of Habit was originally published in Titans Of Investing on Medium, where people are continuing the conversation by highlighting and responding to this story.