The first principle is that you must not fool yourself–and you are the easiest person to fool.
A Real Cargo Cult
An example of cargo cult analysis would be expecting to predict future market returns from P/E Ratios or believing you can pick money managers who can overcome a 2% and 20% hurdle vs. a low-cost index fund. See pages 21-24:Berkshire Hathaway AR 2016. Why Buffett is winning his $1 million dollar bet against fund of funds manager, Ted Seides.
A READER WRITES:
The cargo cult mindset — mindlessly aping something without understanding *how* it works — is rampant. E.g. young people who “go to college” and end up unemployed or making minimum wage. They’re not much different than the islanders who made fake airplanes and control towers based on simple observations.
“So I wish to you—I have no more time, so I have just one wish for you—the good luck to be somewhere where you are free to maintain the kind of integrity I have described, and where you do not feel forced by a need to maintain your position in the organization, or financial support, or so on, to lose your integrity. May you have that freedom.”
If we look at the active management world, we see many (most?) asset managers don’t have such freedom. It’s for that reason that Jeremy Grantham believes career risk is what dominates investing. Better to be wrong collectively and focus on relative returns, right?
Fast-forwarding some years, we see Feynman having such freedom during the investigation of the cause of the Space Shuttle Challenger disaster; he was an effective investigator precisely because he wasn’t beholden to NASA and was motivated by the pursuit of truth. His “Appendix F” in the Rogers Commission Report is another must-read: https://science.ksc.nasa.gov/shuttle/missions/51-l/docs/rogers-commission/Appendix-F.txt
Feynman eschewed the “standard” investigative approach and instead wandered around and talked to engineers and technicians, to the consternation of Rogers and others. (Didn’t W.E. Buffett and/or one of his associates do something similar after the Salad Oil Swindle hit AMEX in the ’60s? He saw that actual AMEX customers didn’t much care, so decided to go ahead with his investment.)
In Appendix F, Feynman uses basic engineering concepts and “numbersense” to expose NASA’s defective management culture. The disparity between the engineers’ estimate of flight risk and NASA management’s is astounding. The lesson here is that you oftentimes don’t need very much to sense-check, or falsify your hypothesis — the whole being generally right instead of precisely wrong concept. Going back to the Salad Oil Swindle, the whole thing would’ve never happened if anyone involved decided to reconcile the deposit receipts (known) to the USDA report on national salad oil production (known) to see how the receipts were inflated to the point of absurdity. Looking back at various case studies of failed investments, how often were the warning signs staring us right in the face if only we thought to look?
Since this is an investing website, we might modify Feynman’s closing sentence to something like, “For a successful investment, economic reality must take precedence over public relations, for you cannot fool everyone forever.”