The “Rashomon Filter” to Make Good Investment Decisions

Heard of the Rashomon effect?

It is a term related to the unreliability of eyewitnesses. It describes a situation in which an event is given contradictory interpretations or descriptions by the individuals involved.

The effect is named after Akira Kurosawa’s 1950 film by the same name ― Rashomon. The story revolves around a murder described in four subjective, alternative, self-serving, and contradictory ways by four witnesses.

Each of the characters relate the incidents as a contradiction of the other, but they describe them in such a convincing manner that the audience tends to believe them all.

Now, even though we may not want to admit it, we play Rashomon’s characters in our lives almost all the time. We tend to see what we want to see. We tend to believe what we want to believe. And we are not alone in this. Everyone behaves the same way.

It is true in investing too.

Consider the reason you bought a stock few months back on a tip you received from a friend or your friendly broker, that is now down 50% in price. You bought the stock because it fit your version of reality then, and you convinced yourself well about it. Now, when it is down 50%, you may be cursing yourself or the belief you held while buying it, which is now altered just because the stock has fallen in price. Now, your version of reality, looking at the stock price, may be different.

“Oh, it was never a good business and I should have never bought the stock!” you may be telling yourself after the 50% fall. And then you may also be contradicting yourself by holding on to the stock just because you want to get your cost price back, despite knowing it is a bad business.

It is a complete mess. And it happens with almost everyone.

We describe our beliefs – that often change with time – to ourselves in such convincing manners that we are always sold on them, even when we are wrong…and especially when we are wrong (which we only realize in hindsight). Worse, the way we believe others talking their own narratives, we ignore that their opinions and analysis may also be subjective and self-serving, like Rashomon’s witnesses.

Anyways, given this weakness of the mind, how do we build a safety net that serves us well in our investment decision making?

A “Rashomon filter” may help here, which assumes that whatever we and others believe about investment decision making, is subjective, self-serving, and contradictory (that’s like, guilty until proven guilty!). And that is why we must always be extra careful when we come across –

• Predictions, which are almost always wrong, even from the smartest around (Howard Marks – “The investment business is full of people who got famous for being right once in a row.”)
• News (Nassim Taleb – “To be completely cured of newspapers, spend a year reading the previous week’s newspapers.”)
• Stock tips (Jesse Livermore – “How people want tips! They crave not only to get them but to give them. There is greed involved, and vanity. It is very amusing, at times, to watch really intelligent people fish for them. And the tip-giver need not hesitate about the quality, for the tip-seeker is not really after good tips, but after any tip. If it makes good, fine! If it doesn’t, better luck with the next.”)
• Consensus views, which are often wrong (Abba Eban – “Consensus is what many people say in chorus but do not believe as individuals.”)
• Our own views, which are often subjective and self-serving than matching reality

The truth is that, most of the time, we do not really know why the things that work in investing actually work. But we still need to work (invest), and put our best foot forward at it. And that is why, the simple idea of knowing that you do not know and then buying into…

• High quality businesses (+20% ROCE + moderate to high earnings growth + clean balance sheet; overall clean financials than do not lead to tough questions and showcase the business’ capacity to suffer through bad times), and
• High quality managers (owner-operator), who do not just have a passion for their business but are also focused on judicious capital allocation, profitable growth and value creation. Plus, they are transparent, ethical and long-term oriented, and have adequate experience in steering the business well over multiple cycles, and
• Reasonable valuations, thereby having adequate margin of safety built into the stock price, because you don’t know what the future will bring

…is a good way to top up your Rashomon filter of what to avoid in your investment decision making, with what to do.

It is a cliché but remember that investing well is simple but not easy. But, despite all the hardships – the mistakes and the misses – that investment decision making involves, it is a journey that is well worth it.

And the easiest way to start this journey is with an admission of ignorance. Because that will bring you the desired humility of knowing what you know, what you don’t, what matters, what doesn’t, what is in your control, what is not, and where you would like to reach at the end of it, and where you wouldn’t.

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Stay safe.

With respect,
— Vishal