Shane Parish isn’t yet a household name but over the last two years, he’s become one of my favorite thinkers and writers. Here are five mental models from his complete list of 109 with comments on how you can apply them to your investment thinking. The goal of this article is to help you find new answers to old questions by altering the way you look at the problem.
Inversion changes the starting point of your thinking by solving a problem backward, inside out, or upside down. This could mean focusing on the outcome you want to avoid rather than the outcome you desire. Successful fixed income investors practice this by prioritizing avoiding losses above all else. Inversion often leads to simpler, less invasive and cleaner solutions. Read more about financial inversion and investing in our anti-goals article. Should you make more or spend less? Reach ever higher or protect what you have? What financial goals can you invert to find better solutions for yourself?
Fragility – Robustness – Anti-fragility
Nassim Taleb wrote his book Antifragile in 2012 to highlight the reality that not all assets react poorly to chaos. One useful method for ranking investments is by fragility — with the top being the most fragile and the bottom being the assets that will gain in value during chaotic events. Sophisticated institutional investors can implement options or CDS strategies to achieve anti-fragility. For the average investor, life insurance is an anti-fragile investment that provides benefits for your family in the event of chaos. Cash can also be considered an anti-fragile asset because it provides for opportunistic investing when markets are falling. Which of your investments would be considered anti-fragile? Where could you add more anti-fragility to your investment life?
Margin of safety
Famed Boston value investor and founder of Baupost, Seth Klarman, wrote his book, Margin of Safety, to highlight this key tenet of value investing. Investing is a probabilistic activity, meaning you are rarely certain that an investment will behave the way you want it to. Investors who focus on creating a margin of safety in their investment life will last longer, end up relying less on hope, and will have more control over their investment outcomes. What is your current margin of safety? How has it changed over time and why?
Multiply by zero
It’s self-evident that any number, no matter how large, when multiplied by zero will result in a zero. This mental model, related to inversion, suggests that if you can remove the potential zeros in your life you will experience a net increase in certainty and control. Size can’t protect against a zero. For example, all stakes in the multi billion dollar unicorn startup Theranos quickly went to zero once the fraud took hold, with no exit opportunity on the way down. For this reason it’s prudent to discount the net worth of your private holdings until the exit is visible on the horizon. Public companies can and do go to zero and private companies can go to zero even faster. By comparison, for a major ETF to go to zero our entire economic system would have to dissolve. Where are there zeros hidden in your portfolio and financial life?
Evolution by natural selection
The best survive and thrive while the others fade away or disappear altogether. This is one reason we prefer market cap weighted investments and it’s a major criteria for selecting a fund to invest in. Low asset funds are more likely to be closed prematurely and tend to have low trading volume, low liquidity and wide bid ask spreads. Clever marketing or perverse incentives for brokers can help the weaker products survive longer than they really should. Over 500 ETFs have been shut down over the last 5 years. Just as in nature, market conditions change and investments need to adapt.
A good advisor should ask probing and thoughtful questions to uncover new and interesting truths that will help with the growth and longevity of your portfolio. We’re here to help you ask these questions and find the right answers that fit in with your unique investment life. Sometimes, landing on the right mental model is a key step in that direction.
PS – you can read the full list of Shane’s 109 mental models here