Audacious Humility: The Key to Success for the Enterprising Investor.
Seeking above market average returns — risk adjusted — is an audacious goal. To generate superior returns, by definition one has to bet against the consensus, which is baked into the market price, and be correct.
To say that the market is wrong, and you’re right, and bet on it, is most certainly audacious. And in the case of the overwhelming majority of institutional and individual investors alike who try and fail consistently, it’s often delusional.
And yet, some investors consistently make good on their audacity, and do generate superior risk adjusted returns over their careers — so consistently so, as to be impossible to attribute to chance alone. And there are certain traits which all of them share ubiquitously.
One of those key ubiquitous traits which separate those who are audacious and succeed, and those who are audacious and fail, is what I would term “true” humility.
Humility is deeply misunderstood. I’m often surprised at just how negative an image the word invokes for some people! To many, “humility” is synonymous with “meek,” “timid,” or “lacking confidence.” Nothing is further from the truth, however.
True confidence requires conviction, and true conviction requires humility.
A good analogy is what goes into forging a good sword. The analogy may be somewhat lost on modern readers, but I’ll go with it:
A sword forged of soft iron won’t hold an edge, and when bent, stays bent. One forged of steel, and hardened in a quench, is exceptionally hard. It may be very sharp, but it’s extremely brittle — it breaks, rather than bends, and the edge, while potentially sharp (although, I wouldn’t want to try sharpening such hard steel), chips easily. It’s only after first hardening, and then tempering — the act of softening the steel back part of the way to strike a balance between hardness and softness — that you get a blade with a spring temper that is soft enough to be sharpened, but hard enough to hold an edge; soft enough to bend, and not break, but hard enough to spring back, and not stay bent.
It’s the same with conviction and humility.
Confidence in the absence of humility is like a house built on sand. It is weak, fragile, and supported only by ego, wishful thinking, and confirmation bias. It is characterized by insecurity, denial, and foolhardiness. This is hardly the source of the sort of audacity which breeds success. This is not true confidence, but arrogance, or self delusion.
To paraphrase a quote attributed to Mark Twain:
“It’s not what you don’t know that gets you. It’s what you know that just ain’t so.”
The fun thing about investing is that it’s actually both. Both what you think you know, and what you don’t know you don’t know can and will get you.
Humility is about recognizing what you don’t know; what you can’t know; and what you might not know, or might not even realize that you don’t know. It’s the appreciation of the limits of your knowledge and ability.
Ray Dalio — the founder of Bridgewater — often puts it this way:
Success in investing is more about dealing with what you don’t know, than it is about what you know.
There’s often far more that we don’t know, or even can’t know, than what we do know. Good investing is about dealing with, and allowing for uncertainties, and the unknowable. That’s why prudent investors employ principles such as insisting on a Margin of Safety — or “allowing room for error,” for example.
Humans naturally crave certainty over uncertainty. Investors and analysts who are too eager for certainty tend to either grossly over-weigh what can be measured accurately at the expense of what can’t, or they delude themselves into thinking they know more than they do or even can know.
A superior investor has to make peace with uncertainty, but at the same time, account for it and be aware of the risks it entails. This is where both humility and audacity — two sides of the same coin — are vital to success.
Humility asks “what might I not know, or be accounting for, and what might the consequences of those things be?”
Humility asks “does the market know something that I don’t?”
But humility also carries with it the seeds of true conviction, and the audacity to act on that conviction in opposition of the consensus.
Humility begets questions, and the imagination required to identify potential sources of risk which are often overlooked. Combined with an inquisitive disposition and the willingness to think through (and research where possible) the doubts and unknowns which humility raises to the fore, a clearer picture forms of both what you know, and what you don’t know, and allows you to think about the true magnitude and probability of risks pertaining to a given investment.
The thoroughness that humility and a bit of imagination begets results in a deep and broad understanding. When you do form a thesis, even if many questions are unanswered, you can account and plan for those uncertainties, and the potential outcomes which they might entail. You can ask yourself “If I’m wrong about X, what is the potential downside? How might it hurt my investment? Is there anything that offers me protection against the potential outcomes that might occur, and if so, to what degree?”
With this approach, a great many risks that the market disregards and deems acceptable will not appear worth taking to you, and other risks which the market discounts heavily will seem overly pessimistic. By being humble and asking such questions, you can identify instances in which market participants seem to be delusional. Remember that public markets are auctions, and that prudent actors are often not the ones setting prices on the margin. These mispricings constitute opportunities. Your goal as an enterprising investor is to find investments that exceed your standards and more than compensate you for the risks — both known and unknown — which you take. You’re looking for investments where you can understand, and reasonably account for (albeit always imprecisely) the risks involved, and still find the risk reward distribution attractive. When that occurs, you can build a investment thesis on a solid foundation — one that you can stick to for as long as it remains objectively valid.
It’s that well founded conviction which allows you to audaciously bet against the consensus, limiting your downside when you’re wrong, and producing returns far above average when you’re right. It’s that humility — that temperedness — which allows you to be okay with the possibility that you might be wrong, as you most certainly will be some of time. Humility isn’t about always just doubting yourself, and conceding to others. It’s about being brave enough to doubt, and examine those doubts in earnest — leaving those that cannot be answered unanswered, and having confidence in the fact that you’re neither deluding yourself, nor being lead astray by the influence of others.
Successfully audacious investors only takes risks which are understood, contemplated, and allowed for. They aim to be approximately right, and never precisely wrong, employing a wide margin of safety, and do not lack imagination with regards to what can go wrong. It’s this humility which provides them a solid foundation on which to audaciously bet against the consensus, and keep doing so successfully over the long-term.
There are few things as commonly mispriced in public markets as risk, and that is largely due to the fact that the most active participants — those who are setting prices on the margin at any given moment — tend to lack the balanced temperament of a good sword, ahem, investor.
Originally published at https://lukedupont.substack.com.
