Serenity, Insight and Investing

I've been reading Bhikku Bodhi's "In the Buddha's Words", which is an anthology of discourses from the collection of Buddhist scriptures known as the Pali Canon. The message is simple but powerful: "From development of the mind arise happiness, freedom, and peace." He goes on, "Development of the mind... means the development of serenity (samatha) and insight (vipassana). Both serenity and insight are considered necessary to achieve true development. "The cultivation of serenity requires skill in steadying, composing, unifying, and concentrating the mind. The cultivation of insight requires skill in observing, investigating, and discerning conditioned phenomena...While meditators may [approach the two aspects] differently, eventually they must all strike a healthy balance between serenity and insight."

While these precepts form the foundation of one of the world's major philosophical traditions, one does not need to be a Buddhist to see their broad applicability. Stoic philosophy conveys similar ideas. Closer to the current day, Jonathan Haidt's "The Happiness Hypothesis" presents another metaphor, that of the elephant and the rider. The mind is divided between conscious/reasoned processes and automatic/implicit processes. These two parts are like a rider atop an elephant. The rider's inability to control the elephant explains many puzzles about our mental lives. Haidt posits that learning how to train the elephant is key to self-improvement.

Unsurprisingly, I think these ideas provide a useful philosophical basis for the tiny sliver of life that is investing. I've written before about Robert Hagstrom's view of investing as the last liberal art. Investors need a grasp of (in order of least controversial to most controversial) finance, microeconomics, macroeconomics, psychology, history and sociology. All these contribute to insight, i.e. seeing the financial markets as they really are, and being humble enough to create a risk management framework that deals with the uncertainty inherent in investing. Developing insight is certainly more than just being knowledgeable, particularly in this era of Information. It's about trying to develop wisdom. To quote T.S. Eliot, "Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?" It's easy to mistake information for knowledge, and knowledge for wisdom. 

That said, even wisdom seems to only be part of the equation. One can be a brilliant analyst but lack the equanimity and humility required to translate good ideas into successful investments.Serenity allows the investor to actually implement an investment, and to maintain an even keel whether things are going particularly well or particularly badly. Anyone observing financial markets comes to realize that they just another medium conveying the vicissitudes of human life. Fear and greed are rightly identified as two emotions that drive much of how we act in financial markets. But market participants experience other emotions too: for example, they experience anger, disgust and shame when taking losses, trust and pride when things appear to be going well, and confusion when market action goes against expectations. The skilled investor therefore needs to be master of his own emotions. Despite his homespun image, Warren Buffett too merges investing acumen with a steely constitution, and the combination has led to his stellar record. Stan Druckenmiller is more of a trader than a value-oriented investor, but my former boss Scott Bessent, in "Inside the House of Money", describes Druckenmiller's toolkit as such: "Stan may be the greatest moneymaking machine in history. He has Jim Rogers' analytical ability, George Soros's trading ability, and the stomach of a riverboat gambler when it comes to placing bets." 

The emotional component to investing is well-recognized these days, with books like Kahneman's "Thinking Fast and Slow" popularizing behavioural economics. Kahneman uses the terms System 1 and System 2 to represent fast, unconscious thoughts and slow, effortful thoughts respectively - analogous to Haidt's elephant and rider respectively. But despite Kahneman's literary success, my guess is that investors still pay far less attention to this side of investing than they should. While there are numerous mainstream avenues to develop the analytical tools of investing (again, just one part of insight, in my analogy), such as going to business school or getting the CFA qualification, these tools are not worth very much without a sound emotional grounding. In fact, they can even be harmful, creating the illusion of certainty where none exists. 

Sadly, there aren't schools devoted to helping investors gain the type of serenity they need. Most investors (retail and professional) succumb to those old enemies, fear and greed, far too often, leading to sub-optimal investment performance. Perhaps we all need to take a step back to learn from Druckenmiller and Buffett - and maybe even the Buddha.