Howard Marks is the Chairman and cofounder of Oaktree Capital Management and author of The Most Important Thing: Uncommon Sense for the Thoughtful Investor. In the book, Marks explains why second-level thinking (sometimes referred to as second-order thinking) and being a contrarian is so important.
Let’s take a look at what second level-thinking really is and why mastering it is so important to anyone with investment and business interests, professional and personal.
Beating the market with second-level thinking
On the basis that anyone can invest in an index fund and achieve ‘market returns‘, Marks views the definition of investment success as being the ability to ‘beat the market’. To accomplish that, you need either good luck or superior insight. However, counting on luck isn’t much of a plan, so his advice is to concentrate on insight. And since other investors may be smart, well-informed and highly computerised, you must find an edge that they don’t have.
In his September 2006 Memo Dare to be Great, Marks explains ‘unconventionality’ and highlights his matrix for second-level thinking.
Great questions that second level thinkers ask
In his September 2015 Memo It’s Not Supposed to be Easy, he explains the difference between first and second-level thinkers and gives examples of the sorts of questions a second-level thinker asks.
First-level thinking is simplistic and superficial, and just about everyone can do it. All the first-level thinker needs is an opinion about the future. Second-level thinking is deep, complex and convoluted. The second-level thinker asks:
- What is the range of likely future outcomes?
- Which outcome do I think will occur?
- What’s the probability I’m right?
- What does the consensus think?
- How does my expectation differ from the consensus?
- How does the current price for the asset comport with the consensus view of the future, and with mine?
- Is the consensus psychology that’s incorporated into the price too bullish or bearish?
- What will happen to the asset’s price if the consensus turns out to be right, and what if I’m right?
On being a contrarian and holding non-consensus views
The upshot is simple: to achieve superior investment results, you have to hold non-consensus, contrarian views regarding value, and they have to be right. That’s not easy… The good news is that the prevalence of first level thinkers increases the returns available to second level thinkers. To consistently achieve superior investment returns, you must be one of them.
In business, and life in general, ultimate success often lies in combining unconventional behaviour with favourable outcomes; the need to think and act like a contrarian. After all, logic dictates that if you follow the crowd then you can’t beat the crowd. As Marks says:
You must learn things others don’t, see things differently or do a better job of analyzing them – ideally all three.
I’m Richard Hughes-Jones, an Executive Coach to senior technology leaders
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