I haven’t done link posts on Putanumonit for two main reasons. I waste enough hours reading stuff on the internet, I hardly need extra encouragement to do so. Also, when I come across a great idea I want to analyze and write about it, not just post a link with a blurb.
But in the last few weeks, I’ve come across a lot of good writing on topics I already covered on this blog. This means either that every important writer on the internet is inspired by Putanumonit, or that I need to diversify my reading. I’d say it’s fifty-fifty which one it is.
I’ll take this opportunity to compile a few links with extended quotes, and see how they relate to my previous posts. External links are green as usual, links to the Putanumonit posts that inspired them are in orange.
My own plan to get rich slowly involves passive index investing, so I don’t read a whole lot about finance. I do however read Matt Levine because every paragraph he writes is a gem, especially when he writes about passive index investing:
A central fact of markets is that “after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar.” There are some caveats, but this is basically a matter of arithmetic, and doesn’t rely on any assumptions about market efficiency.
But that is not in itself a reason to choose passive management. You could just invest in an above-average active fund, and still do better than passive funds after costs. The problem is not just that the average active fund will underperform the average passive fund, but also that it’s very hard to tell in advance which active funds will outperform: Most top funds one year aren’t top funds the next. So how can you pick one that will be?
The trick for an active manager who wants to be successful in this age of skeptical and scientific investing is to have a compelling answer to that question: not blather about its tradition of stewardship or its commitment to investors, but rather to lay out a set of objectively observable criteria for how to pick an active fund, show that those criteria repeatably predict outperformance, and show that it meets those criteria. And Capital [Group]… kind of does that?
Capital’s analysis of historic fund performance — research that has been corroborated by Morningstar, an industry data provider — has shown that two factors are strong indicators of long-term, market-beating returns: fund managers having plenty of their own money in a fund; and low fees. Capital scores well on both measures.
These criteria strike me as surprisingly underpowered — are there really a lot of mutual fund managers who don’t put their own money in their funds? — but they apparently work.
I have several friends and uncles who are renitent to the idea of passive investing. They regale me with stories of how they researched this great stock that then went up 80% and made a ton of money.
When this happens, I first get them to admit that their “research” consisted of watching CNBC for 10 minutes. Unfortunately, CNBC can’t even explain the past, let alone predict the future. We have CNBC on 24/7 at our office, and the following story is very illustrative of their programming:
In February, Trump tweeted that Nordstrom is “Terrible!” for dropping his daughter’s clothing line. I immediately told my friend “Nordstrom knows that their customers are educated rich women who mostly oppose Trump, I bet their stock shoots up”. Nordstrom’s stock immediately fell 1% . The headline on CNBC read “Nordstrom is down because of Trump tweet”. After barely four minutes, the stock started climbing and finished the day up 5%. CNBC informed us that “Nordstrom is up despite Trump tweet”. Either they misspelled “because” as “despite”, or CNBC knows less about markets than I do, and I know precisely zilch.
After explaining how CNBC works, I get my friend/uncle to admit that they didn’t actually buy the stock, they just thought about it and then saw it go up. But they could’ve!
Then my fruncle says that maybe he isn’t informed enough to beat the market, but he knows the guy who is and I should check out that guy’s fund and give him all my money plus 2.5% fees.
As Levine explains, picking a fund that outperforms the market is much harder than outperforming the market yourself. Not only is the average fund doing worse than a dizzy raccoon shooting blow-darts, but the better-than-average hedge funds invest more of their own money, which means that they need less of your money. This creates a selection bias: the funds you will hear about are the ones who want your money. If they want your money, they’re bad funds.
A popular approach for active managers these days is to try to speak the language of passive management. Often the way to do this is sort of cheap and superficial: You hand-pick a list of stocks, call it an index, and call yourself an index fund. (Or, even better, an exchange-traded fund.) You’re still picking the stocks based on gut instinct, and you’re still charging active-ish fees, but the words “index” and “ETF” soothe investors who know that they’re supposed to invest in passive funds.
This is the worst of all worlds: high fees, low diversification, and you’re dealing with crooks. You know what to do instead.
Speaking of making good decisions, The art of rationality draws a lot from the behavioral economic research on biases in decision making. Phil Rosenzweig wrote Left Brain Right Stuff and went on EconTalk to explain how this research is often misinterpreted:
Russ: The other part of it I thought was so interesting–there’s a number of things I don’t like in the literature on this so-called overconfidence. ‘How long is the Nile River?’ is a typical question and ‘How confident are you of your answer?’ Well, we haven’t thought about it that much. If I get it wrong I can look it up; I’d never guess it if it was important. I’d look it up. […]
At least half of my fellow graduate students thought we were in the top 10% of our class. Maybe even the top 5%. And I like to think that most macroeconomists, a disproportionate share of macroeconomists think they have an inside shot at being Chair of the Fed. And that distorts their view of the Fed, unfortunately. So I think there’s obviously, sometimes we overestimate our abilities. But as you point out, there are many times we underestimate them.
Phil: This one word [overconfidence] has been used to mean three very different things. First of all, when people say, ‘Oh, yeah, I’m 90% sure of this,’ and it turns out actually they should be much less–were too precise. We tend to be too precise in ranges that we give or our certainty about certain events. A second thing, you mentioned the word ‘overestimation.’ There is that, too. If I think I can complete a project in 6 months and actually I can’t, or if I think I can high-jump 6′ and I can only do 4′, that’s overestimation. But then the third one, and you touched upon this: when I think I’m in the top 10% and a whole bunch of us think we are in the top 10%, that’s a third one that’s overplacement.
Now, let’s just stop there. Overestimation, overprecision, and overplacement. If you look at the work on overconfidence, we tend to mean one of those three at any given time. And we kind of go back and forth among them using evidence of one to claim another. What the research shows is, regarding overprecision–yes, there is very robust evidence that most people are over-precise much of the time. When I say I’m 99% sure, it’s not really 99%. Part of it has to do with just the way I use words.
Some people complain the LessWrong uses too much jargon, but jargon is necessary to sharpen the concepts and avoid calling three or four unrelated things “overconfidence”. For example, overprecision we usually call miscalibration. Calibration has to do with predictions, not with leadership, and you can practice it by playing a fun game.
Overplacement is interesting:
Phil: There are some examples where people do tend to overestimate their abilities. But there’s other examples where people underestimate their abilities. How many times have you heard somebody say, ‘Oh, I’m no good at math.’ Or how many Americans say, ‘Oh, I could never learn another language.’
Russ: I really like your analysis of the driving example. We don’t have a lot of information about lots of other drivers other than we know we see accidents and we’re not in them every day. And it might be perfectly rational to think at least without more information that you’re better than average. […]
And then lastly: I got a C in art growing up. This was in the days when self-esteem wasn’t–people didn’t worry so much about it. But I grew up thinking I was a horrible artist. Which in some dimension I might be. I don’t know. But I assumed I could never learn to draw. And about 10 years, maybe 15 years ago, my wife and I decided that we were going to learn how to draw, or at least give it a shot. And it turns out, you can actually learn to draw. Almost anybody. Even me. Almost anyone can learn to draw a portrait of someone that looks somewhat like them. I didn’t think it was possible. I had underconfidence.
This makes sense: it’s hard to tell the difference between an amazing driver and a decent one, but a really bad driver is visible by the smoke rising from their hood after they lost a game of “chicken” with a tree. On the other hand, bad dancers are undetectable, they simply never dance. But good dancers are clearly visible busting moves like Jagger. It’s quite reasonable to assume that you’re a better driver (better parent, more law abiding, more honest) than average, but that you’re a worse dancer (artist, mathematician).
There two kinds of average: the median and the mean. The median driver is much better than the mean, the latter is pulled down by the long tail of terrible drivers. Similarly, I’m below (mean) average at dancing, and I’m simultaneously better than the (median) average dancer.
Then we get to overestimation:
Phil: And this has been pretty well documented; it doesn’t matter if you look at the 1980s, the 1990s, or just recently. Gee, all these businesses that are founded, half of them are gone after 5 years and 80% are gone after 7 years–and therefore–therefore–most new businesses fail. And therefore the assumption is starting them up was a mistake. And because it was a mistake–you thought you could succeed, you didn’t realize this, and that it was against the odds. And you were overconfident, you neglected base rates, and therefore there’s some kind of cognitive error behind it.
Starting a business, it’s not like rolling dice and let’s see what happens. Because when you roll a set of dice you can’t actually–you shouldn’t be able to–shape them or change them or influence them as they roll. But when you start a business, it’s not a one-time choice and let’s see what happens. You can actively do things along the way to lower your costs, improve your prospects, and so forth.
I agree that measuring success in “number of surviving companies” is missing the point: one successful start up will make enough money to cover the losses of the nine that failed. That’s how come VCs drive Teslas.
The goal of understanding overestimation (AKA optimism bias, or planning fallacy) is to engage in a more complex decision making process, not to replace one simplistic heuristic (“I feel good so I’ll win!”) with another (“people overestimate, so I’ll lose!”). The correct process is to start from the base rate, and then adjust based on the improvements you can make.
This applies to investing in active funds: you have to start from the realization that your chance of picking a fund that will take your money and beat the market (after fees) is way below 50%, maybe below 20%. Now you know the gap that must be overcome to make active investing worthwhile, and you can compare your skills and advantages against it. If the challenge seems too daunting, you know what to do instead.
Speaking of money, a year ago we gave $9,000 to GiveDirectly’s trial of basic income in Kenya. Here’s what that money is doing, according to the New York Times story about the project:
“Every registered person will receive 2,280 shillings” — about $22 — “each and every month. You hear me?” The audience gasped and burst into wild applause. “Every person we register here will receive the money, I said — 2,280 shillings! Every month. This money, you will get for the next 12 years. How many years?”
Just like that, with peals of ululation and children breaking into dance in front of the strangers, the whole village was lifted out of extreme poverty. The nonprofit is in the process of registering roughly 40 more villages with a total of 6,000 adult residents, giving those people a guaranteed, 12-year-long, poverty-ending income. An additional 80 villages, with 11,500 residents all together, will receive a two-year basic income. With this initiative, GiveDirectly — with an office in New York and funded in no small part by Silicon Valley — is starting the world’s first true test of a universal basic income.
I was asked why I prefer GiveDirectly to charities that help in more specific ways like with medicine or education. The reason is simple: I am not smarter than Kenyans about what Kenyans need.
Cash was more valuable to its recipients than the in-kind gifts commonly distributed by aid groups, like food or bed nets or sports equipment. If you’re hungry, you cannot eat a bed net. If your village is suffering from endemic diarrhea, soccer balls won’t be worth much to you. “Once you’ve been there, it’s hard to imagine doing anything but cash,” Faye told me. “It’s so deeply uncomfortable to ask someone if they want cash or something else. They look at you like it’s a trick question.”
Speaking of being deeply uncomfortable, do you remember when I wrote a poem about rationalists? Me neither, it’s too embarrassing.
I did start reading some poetry recently, particularly Robert Frost and Emily Dickinson whose entire oeuvre is now available to you for a mere $0.99. Here are my favorite rationality related excerpts from each:
For, dear me, why abandon a belief
Merely because it ceases to be true.
Cling to it long enough and not a doubt
It will turn true again, for so it goes.
Most of the change we think we see in life
Is due to truth being in and out of favour.
– Frost, “The Black Cottage”
“Faith” is a fine invention
When Gentlemen can see–
But Microscopes are prudent
In an Emergency.
– Dickinson, 202
To illustrate the pertinence of Dickinson’s poem to the core of rationality, consider this analysis of the poem that concludes:
This poem is a religious one, where Dickinson is speaking about faith and God. She is telling that faith is a blessing from God, which all men and women would see, when there are troubles and difficult times in their life. There are ample amount of ways and instances, which would show them how faith lives in our hearts, and how we have faith during the difficult times.
She uses the scientific terms to just show how religion triumphs science, and science is only a smaller factor of the larger picture. [sic]
As with charts, you can conclude what a poem is about after reading it, or you can decide what it’s about beforehand. It’s much more efficient!
If you’re curious about my own epistemological position on “faith” vis a vis “microscopes”, here are the first messages I exchanged with the woman whom I will soon marry based on a spreadsheet:
Speaking of faith (I’m just crushing the segues today), I broke the story of Hasidic Jews in Brooklyn being secret atheists.
Solomon is one of hundreds, perhaps thousands, of men and women whose encounters with evolution, science, new atheism and biblical criticism have led them to the conclusion that there is no God, and yet whose social, economic and familial connections to the ultra-Orthodox and Hasidic communities prevent them from giving up the rituals of faith. Those I spoke to could not bring themselves to upend their families and their children’s lives. With too much integrity to believe, they also have too much to leave behind, and so they remain closeted atheists within ultra-Orthodox communities. Names and some places have been changed – every person spoke to me for this story on condition of anonymity. Part of a secret, underground intellectual elite, these people live in fear of being discovered and penalized by an increasingly insular society.
It’s not just Dawkins and Dershowitz that make Jews deconvert, it’s medieval rabbis too:
Moishe’s journey from believer to atheist happened in a matter of weeks, after a few passages from Maimonides convinced him that the greatest Jewish scholar was, like himself, an undercover atheist.
Maimonides is really an atheist? I broke that story too.
Anyway, religion isn’t about making people believe in #fakenews (sorry, Sam). It’s about keeping people in a community that behaves a certain way. And of course, everything is about that damned outgroup:
Yisroel has a very good job – he makes in the high six figures – and is very attached to his wife and children, the opposite of the stereotype that prevails in religious communities surrounding those who lose the faith, namely that they are ‘liars who want to do drugs, cheat on their wives and eat cheeseburgers’, as he put it.
But then later:
It’s not all bad. Solomon, who lost his faith on the D train, says there’s a lot of good in the Orthodox community to ameliorate the psychological toll of living a double life, such as ‘the focus on family, the fact that I’m probably not going to have to worry that my daughter’s getting pregnant or stoned at 16. There’s a lot of good, even if none of it’s true. I think it’s a nice life.’
That last part is mind boggling. After Solomon gets off the D train downtown, it goes through the Upper West Side of Manhattan where secular Jewish 16 year old girls volunteer at soup kitchens the better to look on their Ivy League college applications. They don’t get pregnant or stoned – that would mess up their juice cleanses!
Alas, it’s easier to forsake the core belief your entire life was built on, than it is to tolerate the outgroup.