I first heard Rory Sutherland speak in an interview he did for the State of the Markets podcast. Unlike almost every other interviewee he stood out as being able to make completely nonsensical suggestions for why people behave the way they so, but in a way that actually kind of made sense.
So when his new book (Alchemy: The Surprising Power of Ideas That Don’t Make Sense) came out I jumped at the chance to read it. While not obviously a book related to commodity markets, macroeconomics or investing more broadly the book has some interesting insights that I will certainly be taking on board.*
Be an alchemist
As some of you may know my background is economics, but as a number of my posts will attest I’m not wedded to the notion that economists have all the answers, nor that they are necessarily correct. Indeed, I’d rather be, and feel much more comfortable floating around the edge where at least I have a chance of being able to see other perspectives*:
“The alchemy of this book’s title is the science of knowing what economists are wrong about. The trick to being an alchemist lies not in understanding universal laws, but in spotting the many instances where those laws do not apply”
In the real world investors, business owners and others with skin in the game care shouldn’t care that one thing led to another in some rational, logically thought out way. What they really care about, and what really drives their decisions might be something else entirely:
“…we would all benefit if we learn to accept the fact that our unconscious motivations and feelings may have remarkably little to do with the reasons we attribute to them.”
Context matters…a lot
Indeed, context matters a lot more than economists give credit. We are of course a social animal and the context in which decisions have to be made matter far more than simple experiments suggest.
Rory recounts a story from Nassim Taleb’s book Skin in the Game, in which someone explains how depending on the context has entirely different political preferences: ‘At the federal level I am Libertarian. At the state level, I am a Republican. At the town level, I am a Democrat. In my family I am a socialist. And with my dog I am a Marxist.”
Conventional logic can only get you so far
If as investors we always think in the same rational way then we’re all likely to go into the same markets as everyone else. That’s okay if you are early, but apart from those with a seriously long term horizon that’s becoming increasingly difficult for the average investor.
“The fatal issue is that logic always gets you to exactly the same place as your competitors.”
Escaping ‘group-think’ by using nonsensical reasoning opens up new opportunities that others miss. While institutions have to rationally explain their logic for different strategies, you don’t have to do that. This gives the individual (private) investor a distinct advantage:
“…it doesn’t always pay to be logical if everyone else is also being logical. Logic may be a good way to defend and explain a decision, but it is not always a good way to reach one.”
There may be better ways of meeting your objectives than going down the conventional routes. As Rory says in the book abandoning having to appear logical can open our eyes to cheaper, faster acting and more effective solutions:
“The mythical ‘butterfly’ effect’ does exist, but we don’t spend enough time butterfly hunting.”
When making decisions under uncertainty, consider the variance, not just the average
Rory describes making decisions under uncertainty is like travelling to the airport to catch a flight. You can use Google Maps to calculate the optimal time to leave the house, taking account of the distance and the current traffic conditions. But this leaves no room for error, especially if Google suggests you take the motorway. What if there is an accident? Suddenly the ETA jumps 50% and you’ve missed your check-in. As Rory suggests sometimes taking the slower, sub-optimal route is the better bet:
“Remember, making decisions under uncertainty is like travelling to Gatwick Airport: you have to consider two things – not only the expected average outcome, but also the worst-case scenario. It is no good judging things on their average expectation without considering the possible level of variance.”
You could argue that only considering the average result has been the core reason behind many a folly – the Great Financial Crisis the most pertinent example. To borrow another Taleb quote (not in Rory’s book), “Don’t cross a river if it is four feet deep on average.”
For while the majority of investors only consider the average outcome, taking account of the potential variance can increase the likelihood of capturing asymmetric returns, while also reducing the chances of a catastrophic event wiping out your portfolio.
Rory’s Rules of Alchemy:
1.The opposite of a good idea can also be a good idea.
2.Don’t design for average.
3.It doesn’t pay to be logical if everyone else is being logical.
4.The nature of our attention affects the nature of our experience.
5.A flower is simply a weed with an advertising budget.
6.The problem with logic is that it kills off magic.
7.A good guess which stands up to observations is still science. So is a lucky accident.
8.Test counterintuitive things only because no one else will.
9.Solving problems using rationality is like playing golf with only one club.
10.Dare to be trivial.
*As a side note (but probably the most important recommendation I’m going to make in this whole article) I find books on the edge of something I’m interested in often have the most valuable insights. This book doesn’t disappoint.
*One of my favourite quotes in the book, “A change in perspective is worth 80 IQ points.” – Alan Kay (computer graphics pioneer)