The Paradox of Habit Part II: Antonyms of Creative Thought

"Here then we have the paradox. Habits are simultaneously necessary and dangerous, useful and harmful. They undoubtedly save us time, effort, and thought, but at a big expense. They are a prime weapon of adaptation and yet they hinder adaptation. They are problem solutions and yet in the long run they are the antonyms of fresh, uncategorized thinking, that is to say, of solutions to new problems. Though useful in adjusting ourselves to the world, they often hinder us in our inventiveness and creativeness, which is to say they tend to prevent our adjusting the world to ourselves. Finally, they tend to replace, in a lazy way, true and fresh attending, perceiving, learning, and thinking." ~ Abraham Maslow, Motivation and Personality

I like the way Maslow observes habit as "useful in adjusting ourselves to the world."  This is a similar observation I've made in the financial world as it pertains to pattern recognition:  While useful for making decisions, pattern recognition is a form of lazy and potentially damaging habit.  The complacency, for example, in assuming housing prices and incomes would continue rising perpetually strikes at the core of what caused the credit crisis and Great Recession.

Instead of allowing the formation of lazy habit and the complacency of "adjusting ourselves to the world," we must also remain mindful of our human tendency to do so, and to enable "our adjusting the world to ourselves."  As Maslow observes, the paradox of habit is that it is "simultaneously necessary and dangerous, useful and harmful."

What observations have you made of your own useful, yet potentially harmful, habits?

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Related:

The Paradox of Habit Part I: Inertia

Comments

[Benny]

Nice article...
Maybe some doses of awareness is helpful

[Andrew]

Found an interseting article didn't know how to email it to you so posted it as a comment.

While I have read certain works on the life and ponderings of Buddha, I claim no deep knowledge of his philosophy. Note I didn’t use the word “religion,” because Buddha himself claimed no supernatural powers and even begged his followers not to deify him after his death. Hardly had he drawn his last breath, however, when the deification began – though most Buddhists won’t claim it as such.

Even so, there are Buddhist practices I think useful in this hectic world of ours – practices that don’t involve dressing in robes and refusing to swat flies. For example, I rather like to meditate from time to time. Nothing too involved, just ten or fifteen minutes of quiet deep breathing as part of calming the mind and all that.

I also find a lot of wisdom in the training of the Zen archers, who seek to clear their minds of all internal dialogue not related to the simple process of releasing the arrow at the target. Simply, they strive for only one goal – perfect form. Thus they clear their minds of all others, even those that might be considered complementary to the task at hand – for example, getting a pat on the back from the instructor, or plopping the arrow closer to the bull’s-eye than the next person down the line.

Why, even if the attractive maiden serving tea pauses from her morning exertions to admire your shooting, it is verboten to entertain even the slightest thought of trying to impress her with your skills – because having more than one goal divides the mind’s focus and will put you off your mark.

Of course, as humans are wont to do, Buddha’s successors have taken the man’s simple approach to life and wrapped it in gaudy and self-important rituals, in the process turning it into a livelihood for predatory priests. But that’s another story and shouldn’t take away from Buddha’s core beliefs.

Especially the bit about simplifying and focusing your goals. That idea has always seemed to me to have relevance for a wide range of pursuits, from the putting green to the stock market.

It is, however, something I personally struggle with. Just this morning, for example, I arose to help the kids with breakfast, but despite being in the room, my mind had already turned to studying the piano (a goal for 2011), while simultaneously wondering how and when to squeeze in at least 30 minutes of studying Spanish (an ongoing goal). Were that all my brain was juggling, I could manage, albeit not in Zen-like form. But, alas, my mind jumped like a frog on hot pavement to the fact that Friday is also an exercise day for me, then hopped again to the writing of this missive, and other pressing work to be done.

So there I sat, bowl of cereal in front, flanked on either side by my children, while my brain was AWOL, spastically leaping from the piano, to Spanish, to exercise, to writing and other work – all a pleasure to me, and all important to me. However, the result of all of these goals trying to simultaneously crowd into the cranium is the equivalent of a mental Mixmaster.

And so, recognizing the simple reality that it is impossible to actually pursue more than one goal at a time – at least with any competence – I took a deep breath, picked the one activity to start the morning with (the piano), and moved on.

The purpose of mentioning all this, however, is not to reveal your correspondent as a schizoid multi-tasker, but rather to provide what I hope will be some useful perspective on the matter of investing.

Based on my many interactions with investors over the years, I have concluded that there are really just two sorts. There are those that have clear goals, and those who don’t. Those who do make the money. Those who don’t provide the money to those who do (investing in a zero-sum game – for every winner, there is a loser).

This thought was made more tangible to me in recent days, based on a personal experience. Long story short, I had invested in a pre-public company years ago. It wasn’t a big investment, and it took longer than anticipated to ultimately go public. When it did, it had a fairly good run, but as the reason I bought it in the first place was still ahead of it, I hung on. Well, as is so often the case, the company’s missed a hurdle and came tumbling back to earth. With the stock trading hardly at all, and for just a few pennies a share.

Lo and behold, the company’s management reinvented the company as targeting rare earths and managed to acquire a project of merit. The investment that I had written off as worthless soared on high volume.

Now, if there is one thing that anyone with experience in the small-cap resource stocks will tell you, is that the time to sell is when there is someone to sell to – because absent volume, getting out of a decent-sized position is not easy.

So, there was the dilemma – hold on in the hope that the surprise home run turns into the sort you bestow on your grandchildren? Or secure your gains by selling and moving on?

At the point of such a decision, the mind gets very un-Zen-like. Visions of untold riches dance in the head, followed by fits of fretting as the stock pulls back. Next thing you know, you are tossing and turning in the night, conflicting thoughts chasing each other around like cats.

In the final analysis, I recalled the old adage that pigs get fat but hogs get slaughtered. I sold enough to take my initial investment off the table, and a healthy profit – holding on to a modest position to enjoy any further upside. And, having done so, the internal dialogue came to an abrupt halt.

Now, the funny thing is that after a brief pause, the company is again moving up – but I have no intention of second guessing my decision to sell when I did. On a percentage basis, my returns were in the moon shot category – the sort that only the junior resource sector can produce – so it would be just plain churlish to gripe.

More to the point, the stock could just as easily have peaked and once again collapsed, in which case I would really feel like a dolt had I not taken an exit.

All of which delivers me to the point. Namely that it is very important, especially for the resource investors among you, that you actually have a firm goal in mind for each investment you make – and that you remain single-mindedly focused on that goal.

Do you own gold or silver as a protection against inflation? If so, then why even bother checking the price on a daily basis, let alone every few minutes?

Or do you own it as a speculation? If so, what is your specific profit target? Don’t have one? If not, then it seems to me a bit like setting off on a journey without knowing where you want to actually go.

Do you know exactly why you own the resource stocks you do? What hurdle are you betting they will clear next, and by doing so ratchet the price higher? Is your goal to get your original investment off the table on a double? Or do you have a specific price target in mind, at which point you will close the position entirely and move on to more fertile ground?

This idea of keeping an easily understood, single goal in mind for each of your investments is hugely important, because without it you are going to be susceptible to the fears, fantasies, and folly that ultimately cause investors to end up on the losing side of the equation… by selling good companies on pullbacks, holding on to positions well past the point of reasonableness or chasing stocks after they’ve spiked.

Probably the most successful investor I know – I won’t say his name, because he might not like my pointing out that he has tucked away close to a billion dollars, thanks primarily through investments in the resource sector – has a well-deserved reputation for selling too early.

While it is remarkable that he has made so much money in this sector, what is more remarkable is how he did it. Which I would sum up as follows…

First and foremost, he follows a process – almost mechanically.

He buys low, with a specific objective in mind. Both in terms of hurdles he expects the company to clear, but also in terms of the returns he expects to get on his investment.

When his return objectives are met, he sells. Maybe enough to get his original investment off the table, maybe the entire position – depending on his reassessment of the company’s potential to clear the next hurdle. But he always sells at least enough to get his original investment off the table, no matter how much exciting news there is and how much optimism others may feel about the stock.

He only buys on his own terms. If invited to participate in a private placement, he will do so only if he is completely comfortable with the terms. If the company is offering a warrant with a one-year expiration term and he thinks the development work will take two years, he’ll ask for a two-year warrant. If the company won’t budge, he moves on, confident in the knowledge that there will always be another deal coming down the pike.

He’s careful with his money. As he likes to say, if you spend your dollars, they can’t mate and make you more dollars.

He’s not afraid to concentrate investments, but again on his terms, and only when he has done the due diligence needed to be confident that the potential reward warrants the level of risk involved.
If those principles and practices sound simple, it is because they are. But following that process is also incredibly effective.

Interestingly, this process rhymes with the finely honed investment methodologies of the late great Benjamin Graham, author of The Intelligent Investor and mentor to a small cadre of close associates that included Warren Buffett, Jean-Marie Eveillard, William Ruane and Irving Kahn – all of whom used what they learned from Graham to become billionaires, or close to it.

Let that sink in for a moment. One man, Graham, developed a methodology for investing – and it’s actually a pretty simple methodology – that the people working with him were able to duplicate in building their own fortunes. Following a proven process works.

And while Graham wouldn’t have touched a junior resource stock with a twenty-foot pole – his methodology was focused on balance sheet analysis, not a strong point for junior exploration stocks that have no E in their P/E – the principle of following a specific process that mitigates the odds of a loss holds up well. The proof in the pudding is the success of my aforementioned friend, and many others I know who are similarly disciplined. (Our own Marin Katusa, to name just one.)

With all of that said, do you know why you own what you own? Do you have a clear goal in mind for each of your positions? Do you know how much of your portfolio is allocated to speculative resource plays, and are you comfortable with the idea that those stocks have historically suffered extreme sell-offs?

Warren Buffett, whose investment acumen is hard to argue with, likes to quip that the two most important rules for investment success are, Rule #1 – Never lose money. Rule #2 – Never forget rule No. 1.

While it is almost impossible not to lose money along the way while investing in resource shares, it is equally true that once you have scraped your original investment off the table, it is impossible to lose money. Sure, you can give back your profits – but you can’t lose money.

All of which is, I think, worth reflecting on as you aim your next arrow.

[Kent @ The Financial Philosopher]

Andrew:

Thanks for the comment. I, too, believe that practicing the virtues of simplicity, humility and patience can be extremely rewarding, both in investing and in life.

Kent