From Hubris to Humility

Here is my latest podcast on why it is important for you to beware of hubris, whether in investing or life, so that you can keep yourself from risking too much in a view of the future that may turn out to be wrong. Let me know how you find it, and your feedback and suggestions to improve the same.

Audio

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Transcript
On the morning of the Battle of Waterloo on Sunday, 18 June 1815, Napoleon Bonaparte who was leading the French Army against the British army under the command of the Duke of Wellington, assured his soldiers, “I tell you Wellington is a bad general, the English are bad soldiers; we will settle this matter by lunchtime.”

Well, by the end of that day, Napoleon was defeated and that ended his rule as Emperor of France.

Around 100 years after Napoleon’s arrogant remark and defeat, on 15th April 1912, just before the Titanic was about to embark on its maiden journey, one passenger asked a ship’s agent for extra insurance on some valuables in her luggage. The agent replied, “Ridiculous. This boat’s unsinkable.”

Titanic’s Captain Edward Smith himself was asked about the safety of the Titanic. He answered – “I cannot imagine any condition which would cause a ship to founder. I cannot conceive of any vital disaster happening to this vessel. Modern shipbuilding has gone beyond that.”

Then, after the ship had struck the iceberg, a passenger asked her employer if they should do something about it. He replied, “Go back to bed. This ship is unsinkable.”

Move forward another 89 years and consider the example of Enron, and the e-mail that Kenneth Lay, then the CEO, sent to his employees in 2001. He declared, “Our performance has never been stronger, our business model has never been more robust. We have the finest organization in American business today.” That was less than four months before Enron filed for bankruptcy.

You may also remember the story of the American hedge fund Long-Term Capital Management, which was founded in 1994, and was backed by a dream team including Nobel Prize winners and investment banking experts. It succeeded enormously at first, only to eventually succumb to the folly of its managers’ overweening pride as its most sophisticated computer models failed to anticipate common sense economic problems. The fund failed spectacularly by 2000.

You see, the thing is that if you are repeatedly successful, there’s a temptation to believe that you’re no longer subject to human fallibility. But the honest and harsh truth is that in a world that is continually changing, every right idea or strategy eventually becomes the wrong one.

With an arrogant attitude, you cease paying attention to differing viewpoints. Confirmation bias takes its roots in your brain, and you screen out all the sounds that tell you how you’re wrong, and amplify those that tell you how you are right. But then, it’s important to remember that you are not the idea of God that will never be destroyed. And thus, it’s important to beware of hubris. When it bites, it bites hard.

Hubris is basically an overestimation of one’s own competence or capabilities. This is particularly when that person is in a position of influence or power. Now, I know what you’re thinking…you’re thinking this would never happen to you. And it might not to any great degree. Let’s hope it doesn’t.

But the thing about hubris is that you rarely think you have it until it’s already run an unhealthy portion of its course.

Consider investing in the stock market. Open Benjamin Graham’s Security Analysis and the first thing you read is a quote from Horace – “Many shall be restored that now are fallen, and many shall fall that now are in honor.” What could be a better reminder than this to investors who get intoxicated by their own success? And I am finding a lot of such breed these days.

So, whether it is chasing hot stocks (ascribing their rise to their “moats”), or using leverage, or blindly copying/cloning other investors who have seen short-term success, I see widespread arrogance in the stock market. Now, for instance, when you take on leverage and show me the math that a 25% annual return over 10 years minus 12% interest cost can still earn you 20%+ return, please remember Nassim Taleb who says that we should judge people by the costs of the alternative, that is if history played out in another way. As he wrote in his brilliant book Fooled by Randomness –

Clearly, the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voiced only by people who fail (those who succeed attribute their success to the quality of their decision).

In the same way, be very careful when you judge your stock market success by the outcome you achieve, and not by the decision you made.

I am an eternal optimist as far as stock market investing is concerned, but please be very careful of what you are doing with your money and why you are doing it. There are great dangers of hubris while dealing with your money. And the only way you can avoid those dangers is by avoiding hubris.

The legendary investor Seth Klarman said this in an interview with Charlie Rose in 2012 –

You need to balance arrogance and humility…when you buy anything, it’s an arrogant act. You are saying the markets are gyrating and somebody wants to sell this to me and I know more than everybody else so I am going to stand here and buy it. I am going to pay 1/8th more than the next guy wants to pay and buy it. That’s arrogant. And you need the humility to say ‘but I might be wrong.’ And you have to do that on everything.

Staying humble with your analysis and forecasting powers will keep you from risking too much in a view of the future that may well turn out to be wrong.

Don’t be blinded by hubris. A little humility can help you steer clear of disaster, in investing and in life.

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That’s about it from me for today.

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Stay safe.

With respect,
— Vishal