Author: Farnam Street

The Anatomy of a Great Decision

Making better decisions is one of the best skills we can develop. Good decisions save time, money, and stress. Here, we break down what makes a good decision and what we can do to improve our decision-making processes.

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Improving our decision-making abilities is a central goal at Farnam Street. Better decisions save time, money, and stress. While it’s an investment now, in the long run, learning principles and developing a multidisciplinary lens that we can apply throughout life is a worthy investment.

As we have said before, a decision should not be judged solely on its outcome. Sometimes good decisions produce bad results. A recruiting process that has resulted in mostly excellent candidates will still occasionally fail to weed out a bad fit. It is impossible to have perfect and complete information for all the variables involved. So we do the best with what we have.

Using a decision journal can move us to that place where we are consistently making better decisions. At its core, the technique of identifying and reflecting on process from beginning to end helps us achieve the two main qualities in better decisions:

  1. Using principles, not tactics
  2. Looking at a situation through a multidisciplinary lens

These qualities are what we need to improve over time. And in the same way compounding interest increases our bank balance, better decisions produce exponentially better results the more of them we make. Hard decisions today, made well, prepare us to make decisions more easily in the future.

When we look around, however, to see what we can learn from others who made great decisions, we often judge based solely on the outcomes. Whether a decision by a family member to buy Coca-Cola stock in the ’80s, or Caesar to cross the Rubicon, we evaluate a decision as good based on how things turned out.

Evaluating decisions on outcomes prevents us from learning. We need to dive into a decision, cut it open and examine its parts. Regardless of what happened, learning how a decision was made is the place to find knowledge. So what does the anatomy of a great decision look like?

The Marshall Plan

After WWII, Europe was in ruins. Much of the infrastructure had been destroyed. Many people were starving, and had lost everything they possessed. Those systems we take for granted, but on which we rely daily—transportation, manufacturing, agriculture—had been devastated. The economies were essentially broken, and the countries that saw a lot of fighting had much to rebuild. But with what money? Many countries were in serious debt. Continued, widespread economic hardships were on the horizon.

In 1947, Secretary of State General George Marshall put forward a plan that has since carried his name, a plan to give a massive amount of money to several European nations. Those countries accepted, the continent was rebuilt, and Marshall is credited with one of the most positive defining acts of economics, politics, and ethics in the last century. But when you look at the thinking that went into the Marshall Plan, the reasoning behind the details, you see that it would have been a great decision regardless of the outcome.

Asking the Right Questions

At the beginning, participants asked questions. What do we want to achieve? What problems are we addressing? What does a successful outcome look like?

From there came the principles, things like: strong economies minimize social unrest; countries that work toward mutual goals are less likely to fight each other; let’s not have another war in Europe anytime soon.

Starting from these principles, decision makers evaluated the situation through a multidisciplinary lens. Economics, politics, humanitarian responsibilities, historical and psychological factors—the plan sought to address issues on many fronts and took a wide perspective into account.

The plan was developed in the State Department of the United States. It was not the work of a single individual, and contributions from many people made it into the final version that Marshall fought for in Congress.

In the end, there were three key decisions made in terms of the structure of the plan:

  1. To give, versus lend, the majority of the aid
  2. To require the nations receiving the aid to work out how to allocate it
  3. To invite Russia to partake

Using Multiple Lenses

The decision to give rather than lend the majority of the aid was the result of looking at the situation through economic, political, and humanitarian lenses. It was also a win-win.

Immediately following the war, the European nations had put significant effort into restarting their economies. But they were doing it with borrowed dollars, needing to import far more than they were capable of exporting. Many economies needed modernization, which was impossible to fund while paying for imports at the same time. Without full economic recovery in Europe, there was great danger of a recession, or even a second depression. Basically, Europe needed money.

But economies are also about people. It is people who produce and consume and develop the economy. So it wasn’t just the countries that needed financial assistance, but the people in them. The designers of the plan knew that hungry, desperate people would only create more social unrest. They saw that if they didn’t give the money to Europe they might very well have to spend it on national security as Europe fell apart.

And we can’t discount the impact of the physical reality of the aftermath of the war that the liberating forces confronted—starving people, towns reduced to rubble. The case for humanitarian assistance was strong.

Letting the World Do the Work For You

The decision to have the participating nations allocate the aid among themselves was the answer to what the historical, political and psychological lenses revealed.

Many people felt that the approach to reparations after WWI was a significant impetus for WWII. The First World War had a similar effect on the economies and infrastructures of the nations involved. In 1918, angry at Germany, France and Britain had demanded huge sums of money. The problem was, it essentially crippled Germany economically, and caused a social and political situation that created enmity among the European nations. Many argue that it was this series of events that produced a situation in which Hitler could come to power.

The creators of the Marshall Plan were aware of this, and it was one of the elements that influenced the design of the terms. If Germany collapsed again, they might be fighting World War III in twenty years.

By asking enemies to work together and approve each other’s share, the plan created a buy-in that defused much of the anger and animosity between the nations. Just a couple of years earlier they had been at war with each other. After sacrificing so much in both lives and money, it was natural that the various peoples were angry over both who started the war, and the many violent and destructive events that were enacted over those six years.

But the US decided to not take sides and extend the alliances of the war. The plan creators realized this wouldn’t help fulfill the principles they had chosen to abide by. Europe working meant Europe working together.

Outcomes Over Optics

Inviting Russia to share in the aid was another important result of applying those political, historical, psychological, and humanitarian lenses.

The end of WWII marked the beginning of the Cold War. More nebulous by nature, starting a couple of years after the liberation of Europe and the dropping of the atomic bomb, this political climate would shape international relations for the next 40 years. The Marshall Plan took into account how best to navigate this complicated territory. Russia had been a valuable ally during the war, holding the eastern front and inflicting considerable damage on Hitler’s efforts. But immediately post-war their actions demonstrated a desire to at least influence, if not control, the political structure of the world. Their version of communism was at direct odds with US democracy, and was thus considered a legitimate threat.

Even though there was very little expectation that Russia would participate, and possibly even less desire to give them money, Russia and its allied countries were invited by both the US and the European nations to participate in the talks involving the implementation of the plan. They chose not to, and followed up with accusing the plan of being a front to American imperialist goals. This was important because it forced Russia’s hand. They could not later claim that the Iron Curtain was something that was thrust on them. It was, instead, something they deliberately chose to build.

The Marshall Plan is remembered as a great decision, not strictly because of its outcomes—though it did contribute to the debatably successful reconstruction of Europe, it did not succeed in preventing the deterioration of relations with Russia—but because it was firmly grounded in principles that were identified and executed through a multidisciplinary lens.

Footnotes
  • 1

    Sutcliffe, Anthony. An Economic and Social History of Western Europe since 1945. London: Longman, 1996.

  • 2

    Unger, Debi and Irwin. George Marshall: A Biography. New York: HarperCollins, 2014.

The Importance of Working With “A” Players

Stop me if this sounds familiar. There is a person who toils alone for years in relative obscurity before finally cracking the code to become a hero. The myth of the lone genius. It’s the stuff of Disney movies.

Of course, we all have moments when we’re alone and something suddenly clicks. We’d do well to remember, though, that in those moments, we are not as independent as we like to think. The people we surround ourselves with matter.

In part, because we tell ourselves the story of the lone genius, we under-appreciate the role of a team. Sure, the individual matters, no doubt. However, the individual contributions are supercharged by the team around them.

We operate in a world where it’s nearly impossible to accomplish anything great as an individual.  When you think about it, you’re the product of an education system, a healthcare system, luck, roads, the internet and so much more. You may be smart but you’re not self-made. And at work, most important achievements require a team of people working together.

The leader’s job is to get the team right. Getting the team right means that people are better as a group than as individuals. Now this is important.  Step back and think about that for a second — the right teams make every individual better than they would be on their own.

Another way to think about this is in terms of energy. If you have 12 people on a team and they each have 10 units of energy, you would expect to get 120 units of output. That’s what an average team will do. Worse teams will do worse. A great team will take the same inputs and get a non-linear outcome. The result won’t be 120; it’ll be 360.No matter where you’re going, great teams will get you there multiples faster than average teams.

Here is a quote by Steve Jobs on the importance of assembling “A” players.

I observed something fairly early on at Apple, which I didn’t know how to explain then, but I’ve thought a lot about it since. Most things in life have a dynamic range in which [the ratio of] “average” to “best” is at most 2:1. For example, if you go to New York City and get an average taxi cab driver, versus the best taxi cab driver, you’ll probably get to your destination with the best taxi driver 30% faster. And an automobile; what’s the difference between the average car and the best? Maybe 20%? The best CD player versus the average CD player? Maybe 20%? So 2:1 is a big dynamic range for most things in life. Now, in software, and it used to be the case in hardware, the difference between the average software developer and the best is 50:1; maybe even 100:1. Very few things in life are like this, but what I was lucky enough to spend my life doing, which is software, is like this. So I’ve built a lot of my success on finding these truly gifted people, and not settling for “B” and “C” players, but really going for the “A” players. And I found something… I found that when you get enough “A” players together, when you go through the incredible work to find these “A” players, they really like working with each other. Because most have never had the chance to do that before. And they don’t work with “B” and “C” players, so it’s self-policing. They only want to hire “A” players. So you build these pockets of “A” players and it just propagates.

Building a team is more complicated than collecting talent1. I once tried to solve a problem by putting a bunch of PhDs’ in a room. While comments like that sounded good and got me a lot of projects above my level, they were rarely effective at delivering actual results.

Statements like “let’s assemble a multidisciplinary team of incredible people” are gold in meetings if you work for an organization. These statements sound intelligent. They are hard to argue with. And, most importantly, they also have no accountability built in, and they are easy to wiggle out of. If things don’t work out, who can fault a plan that meant putting smart people in a room.

Well … I can. It’s a stupid plan.

The combination of individual intelligence does not make for group intelligence. Thinking about this in the context of the Jobs quote above, “A” players provide a lot more than raw intellectual horsepower. Among other things, they also bring drive, integrity, and an ability to make others better.  “A” players want to work with other “A” players. Accepting that statement doesn’t mean they’re all “the best”.

In my experience solving difficult problems, the best talent available rarely led to the best solutions. You needed the best team. And the best team meant you had to exercise judgment and think about the problem. While there was often one individual with the idea that ultimately solved the problem, it wouldn’t have happened without the team.  The ideas others spark in us are more than we can spark in ourselves.

Footnotes
  • 1

    A play on a quote by Bill Belichick

In the face of adversity, are you a Guernsey or a Brahman?

If the mother of a Guernsey and a Brahma calf dies, one of the calves will survive and one will not. One thing makes the difference. And is it the very factor that keeps us from reaching what we want most.

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Persistence in the face of defeat often makes the difference in outcome.

Ask any farmer, and they will tell you that orphaned Guernsey calves die. It’s not the fact that they die, so much as how it happens, that stays in the mind. An orphaned calf soon gets so hungry she picks a new mother from the herd. The cow promptly kicks the strange calf away. After all, she didn’t give birth to the calf—why should she feed it? The Guernsey calf gives up, lies down, and slowly starves to death.

The orphaned Brahman calf gets a different result. The same scenario plays out, with the calf being kicked out by the reluctant mother. However, in this case, the naturally persistent calf keeps coming, until the potential new mother acquiesces out of exhaustion. As a result of this persistence, the calf survives.

Persistence is hard. It’s hard to get kicked in the face and to keep going. It hits at your self-esteem. You begin to wonder if you have value. You begin to think you might be crazy.

So often we’re told that having a positive attitude is the important thing. You can get through the setbacks if you find the silver linings and believe in what you are doing. But it’s important to remember that persistence and a positive attitude aren’t the same thing. They differ in some pretty fundamental ways.

Positivity is fragile. If you’re positively certain that you’ll be successful, you’ll start to worry the minute things deviate from your plan. Once this worry seeps into your mind, it’s impossible to get out. You’re done. When the going gets tough, positive attitudes often vanish.

Persistence, on the other hand, anticipates roadblocks and challenges. It gears up for the fact that things never go as planned and expects goals to be hard to attain.

If you run into failure, persistence continues, and positivity disappears. Persistence is antifragile and benefits from setbacks, while positivity, like that Guernsey calf, crumbles when it runs into hard times.

When met with setbacks, are you a Guernsey or a Brahman?

Yes, It’s All Your Fault: Active vs. Passive Mindsets

The hard truth is that most things in your life – good and bad – are your fault. The sooner you realize that, the better things will be. Here’s how to cultivate an active mindset and take control of your life.

What happens when someone repeatedly says it—whatever “it” may be—is not their fault?

“It’s not my fault I was late for the meeting. Traffic was bad.”

“It’s not my fault I lost money. I got the stock tip from a friend.”

“It’s not my fault I don’t have the skills for the job and was laid off. They should have trained me.”

I don’t want to get into edge cases. But most of the time these kinds of things are your fault. And if you don’t see that, you’re going to continue to find yourself in these situations over and over again.

You should have planned for traffic. You made a terrible investment and you have no idea what you’re doing. Stop waiting for people to teach you the skills you need to earn a living and go learn them.

When the passive mindset takes over, you say another phrase that drives me batty: “I can’t.” Actually, yes you can, you’re just not willing to pay the price. You’re not willing to do the work or spend the time. You’re not willing to do something hard. You’re not willing to sacrifice what’s needed.

The passive mindset is defined by an attitude, an assumption that life happens to you and you’re not responsible. People with this mindset also say things like, “Why does this always happen to me?”

When the language you use about things going on in your life is passive, you slowly convince yourself that nothing is your responsibility. This makes you feel good because it absolves you from responsibility. It means you don’t have to look inside yourself and change anything.  It means you’re not in control.

Well I have news for you: you are in control. You’re in control of how you respond to the ups and downs of life. You’re in control of how you talk to yourself.

An active attitude means ownership. You own your failures. An active mindset means you are responsible for things you control.

“Sorry, I should have planned for traffic, I’ll consider that next time.”

“Wow, that investment blew up! I really don’t know what I’m doing. Maybe I should learn.”

“I got laid off because I didn’t make myself indispensable. I won’t let that happen again.”

The next time you catch yourself saying “I can’t,” say “I choose not to because….“

“I choose not to go to the gym because….”

“I choose not to learn something new because…” 

“I choose not to eat healthy because….”

It’s not that you can’t do something it’s that unless you have literally done everything, you’re choosing not to because the price is too high. Stop lying to yourself.

Own your choices. Own the process. Take control.

The Stormtrooper Problem: Why Thought Diversity Makes Us Better

Diversity of thought makes us stronger, not weaker. Without diversity we die off as a species. We can no longer adapt to changes in the environment. We need each other to survive.

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Diversity is how we survive as a species. This is a quantifiable fact easily observed in the biological world. From niches to natural selection, diversity is the common theme of success for both the individual and the group.

Take the central idea of natural selection: The genes, individuals, groups, and species with the most advantageous traits in a given environment survive and reproduce in greater numbers. Eventually, those advantageous traits spread. The overall population becomes more suited to that environment. This occurs at multiple levels from single genes to entire ecosystems.

That said, natural selection cannot operate without a diverse set of traits to select from! Without variation, selection cannot improve the lot of the higher-level group.

Thought Diversity

This is why I find it frustrating that we often seem to struggle with diversity of thought. This type of diversity shouldn’t threaten us. It should energize us. It means we have a wider variety of resources to deal with the inevitable challenges we face as a species.

Imagine that a meteor is on its way to earth. A crash would be the end of everyone. No matter how self-involved we are, no one wants to see humanity wiped out. So what do we do? Wouldn’t you hope that we could call on more than three people to help find a solution?

Ideally there would be thousands of people with different skills and backgrounds tackling this meteor problem, many minds and lots of options for changing the rock’s course and saving life as we know it. The diversity of backgrounds—variations in skills, knowledge, ways of looking at and understanding the problem—might be what saves the day. But why wait for the threat? A smart species would recognize that if diversity of knowledge and skills would be useful for dealing with a meteor, then diversity would be probably useful in a whole set of other situations.

For example, very few businesses can get by with one knowledge set that will take their product from concept to the homes of customers. You would never imagine that a business could be staffed with clones and be successful. It would be the ultimate in social proof. Everyone would literally be saying the same thing.

The Stormtrooper Problem

Intelligence agencies face a unique set of problems that require creative, un-googleable solutions to one-off problems.

You’d naturally think they would value and seek out diversity in order to solve those problems. And you’d be wrong. Increasingly it’s harder and harder to get a security clearance.

Do you have a lot of debt? That might make you susceptible to blackmail. Divorced? You might be an emotional wreck, which could mean you’ll make emotional decisions and not rational ones. Do something as a youth that you don’t want anyone to know? That makes it harder to trust you. Gay but haven’t told anyone? Blackmail risk. Independently wealthy? That means you don’t need our paycheck, which means you might be harder to work with. Do you have a nuanced opinion of politics? What about Edward Snowden? Yikes. The list goes on.

As the process gets harder and harder (trying to reduce risk), there is less and less diversity in the door. The people that make it through the door are Stormtroopers.

And if you’re one of the lucky Stormtrooopers to make it in, you’re given a checklist career development path. If you want a promotion, you know the exact experience and training you need to receive one. It’s simple. It doesn’t require much thought on your part.

The combination of these two things means that employees increasingly look at—and attempt to solve—problems the same way. The workforce is less effective than it used to be. This means you have to hire more people to do the same thing or outsource more work to people that hire misfits. This is the Stormtrooper problem.

Creativity and Innovation

Diversity is necessary in the workplace to generate creativity and innovation. It’s also necessary to get the job done. Teams with members from different backgrounds can attack problems from all angles and identify more possible solutions than teams whose members think alike. Companies also need diverse skills and knowledge to keep a company functioning. Finance superstars may not be the same people who will rock marketing. And the faster things change, the more valuable diversity becomes for allowing us to adapt and seize opportunity.

We all know that any one person doesn’t have it all figured out and cannot possibly do it all. We can all recognize that we rely on thousands of other people every day just to live. We interact with the world through the products we use, the entertainment we consume, the services we provide. So why do differences often unsettle us?

Any difference can raise this reaction: gender, race, ethnic background, sexual orientation. Often, we hang out with others like us because, let’s face it, communicating is easier with people who are having a similar life experience. And most of us like to feel that we belong. But a sense of belonging should not come at the cost of diversity.

Where Birds Got Feathers

Consider this: Birds did not get their feathers for flying. They originally developed them for warmth, or for being more attractive to potential mates. It was only after feathers started appearing that birds eventually began to fly. Feathers are considered an exaptation, something that evolved for one purpose but then became beneficial for other reasons. When the environment changes, which it inevitably does, a species has a significantly increased chance of survival if it has a diversity of traits that it can re-purpose. What can we re-purpose if everyone looks, acts, and thinks the same?

Further, a genetically homogeneous population is easy to wipe out. It baffles me that anyone thinks they are a good idea. Consider the Irish Potato Famine. In the mid-19th century a potato disease made its way around much of the world. Although it devastated potato crops everywhere, only in Ireland did it result in widespread devastation and death. About one quarter of Ireland’s population died or emigrated to avoid starvation over just a few years. Why did this potato disease have such significant consequences there and not anywhere else?

The short answer is a lack of diversity. The potato was the staple crop for Ireland’s poor. Tenant farms were so small that only potatoes could be grown in sufficient quantity to—barely—feed a family. Too many people depended on this one crop to meet their nutritional needs. In addition, the Irish primarily grew one type of potato, so most of the crops were vulnerable to the same disease. Once the blight hit, it easily infected potato fields all over Ireland, because they were all the same.

You can’t adapt if you have nothing to adapt. If we are all the same, if we’ve wiped out every difference because we find it less challenging, then we increase our vulnerability to complete extinction. Are we too much alike to survive unforeseen challenges?

Even the reproductive process is, at its core, about diversity. You get half your genes from your mother and half from your father. These can be combined in so many different ways that 21 siblings are all going to be genetically unique.

Why is this important? Without this diversity we never would have made it this far. It’s this newness, each time life is started, that has given us options in the form of mutations. They’re like unexpected scientific breakthroughs. Some of these drove our species to awesome new capabilities. The ones that resulted in less fitness? These weren’t likely to survive. Success in life, survival on the large scale, has a lot to do with the potential benefits created by the diversity inherent in the reproductive process.

Diversity is what makes us stronger, not weaker. Biologically, without diversity we die off as a species. We can no longer adapt to changes in the environment. This is true of social diversity as well. Without diversity, we have no resources to face the inevitable challenges, no potential for beneficial mutations or breakthroughs that may save us. Yet we continue to have such a hard time with that. We’re still trying to figure out how to live with each other. We’re nowhere near ready for that meteor.

An Investment Approach That Works

There are as many investment strategies as there are investment opportunities. Some are good; many are terrible. Here’s the one that I lean on the most when I’m looking for low risk and above average returns.

“The whole secret of investment is to find places where it’s safe and wise to non-diversify. It’s just that simple.”

— Charlie Munger

Goal: An investment algorithm to lean on hard when it is available. Low-risk, long-duration, above-average returns.

There are many paths to investment heaven (and we’ve written on the topic before). The diversity of working approaches demonstrates that. However, fundamentally, any useful approach must do three things:

  1. It must work in all conceivable financial environments.
  2. It must be within the “circle of competence” and “circle of interestingness” of its user.
  3. It must meet the moral criteria of its user.

I believe the system below satisfies the first criterion, and allows for all three.

A 7–Element Algorithm for Equity Investing

Everyone Wins
Successful businesses have indefinitely sustainable business systems: owners, employees, customers, suppliers, all content.

Ballast for the Storm
Look for a sustainable balance sheet, given the capricious nature of the world. Past bad events do not predict future bad events. Sometimes inefficient balance sheets allow companies to survive by positioning them for all environments, not just optimizing for one.

Different and Hard to Match
Candidates must occupy a structurally profitable, indefinitely sustainable business niche, allowing for the truism that all moats are subject to being crossed eventually. There must be an element of mystery.

Operational Soundness
Reliable execution of the “blocking and tackling” of operations is a must. Getting this wrong always costs big, and can ruin a good niche.

A Few Simple Variables
Allowing for the difficulty of predicting the future, candidates should have just a few reasonably predictable economic variables that will dominate their outcomes. In the words of Warren Buffett, “There are all kinds of businesses where we have no idea what they’ll earn this year, let alone any future year.” Look for boring investments, sexy is usually complicated and full of competition. Look for what’s staying the same.

Long Runway
You should be able to foresee an indefinite period of growth ahead, through some combination of market creation, market penetration, and pricing power.

Priced Attractively
Stock should be priced so that stock returns >= business returns, always including a margin for error in forward-looking estimates.

Seemingly missing is the concept of “good management,” but I consider this redundant in light of the first four elements. Any business meeting those criteria is being managed properly, and any investment going 7/7 has a very low probability of failure.

Notice that the word indefinite is used several times. This does not mean the same thing as infinite. There are no infinities in the business world. Indefinite means “as far out as can presently be seen.”

Caution: what psychologists call the “representativeness heuristic” puts us at risk of over-fitting to this or any algorithm. Always be on guard. In the words of Richard Feynman, “Never fool yourself, and remember that you are the easiest person to fool.”

Still curious? Read the parable of how one nation came to ruin.