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Path Dependence: A Lesson for New Investors



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I was going through a few of my journal notes and came across this thought from Nassim Taleb who explained the concept of “path dependence,” which is the dependence of outcomes on the path of previous outcomes, rather than simply on current conditions –

Ironing your shirts then putting them in the washing machine produces a different outcome from washing your shirts first, then ironing them. The reader can either trust me on this, or try the experiment with both sequences on the next Sunday afternoon. Now, assume that your capital is around one million dollars and you are involved in speculation. Apply path dependence to the reasoning.Making a million dollars first, then losing it, is markedly different from losing a million dollars first then making it.

The first path (make-lose) leaves you intact; the second (lose) makes you bankrupt, insolvent, maimed, traumatized and more generally unable to stay in the game, thus unable to benefit from the second part of the sequence. There is no make after the lose.

This note from Taleb reminded me of Warren Buffett’s “Rule No. 1 – Never LOSE money.”

Consider a weak, fragile business. It is path-dependent. With stretched balance sheet, large capital requirement, and inadequate capacity to suffer, a prolonged weakness in the economy can destroy it. It is then difficult for it to rise from that ruin. When you own such a business, you have to do a lot of praying to the economics gods. Such a business starts from a “lose” and now it’s difficult, almost impossible, for it to “make” back what it lost.

On the other hand, a robust and anti-fragile business, with clean balance sheet and low capital requirement, which has built a capacity to suffer over years, is not path dependent. It can survive a weak economy. Even if the weakness persists, at worst, it may lose what it has already made, which is better than starting with losing it all.

So, check out what you already own in your portfolio. Is it in the “make, then lose” category, or “lose, then lose everything” one?

Stick with the former. Discard the latter.

* * *

I have started work on a series of short videos to share my thoughts around investing, decision making, learning, and just the practice of trying to live a good life. Have published the following four videos so far, which you can watch on my YouTube channel –

This initiative has a dual purpose. One, to share my key lessons around the above-mentioned ideas with you in byte-size format, and two, to help me get over my anxiety and shyness to speak in front of a camera (and you can see from these videos how bad I am at these!). I hope, over time, I am able to deliver on both of these fronts. 🙂

* * *

As parents, we often ask, then ask again, and ask again our kids to do something we desire they do. And if we are lucky, our kids cooperate after the fourth or fifth request or after a loud but otherwise harmless scolding.

We complain that our kids never listen to us and ask other parents how they get their kids to behave, eat healthy food, and go to sleep on time. If that’s not all, we consult the Internet and several books on bringing up well-cultured and disciplined children. Then, even as we apply all those techniques, our kids just don’t listen.

But, amidst all this, there’s something we often fail to notice with our kids. Even when they are not listening to us, they are busy observing us.

I have often noticed this with my kids. They would often not listen to what I have to tell them. But they would always be observing my actions. And that keeps me on my toes, simply because my kids are ‘watching’ me.

I found this thought reiterated in this wonderful book I am reading for, maybe, the fifth time – Peter Bevelin’s All I Want to Know is Where I’m Going to Die So I’ll Never Go There. Here is an excerpt from that book where Warren Buffett and Charlie Munger, in conversation with a seeker of wisdom, share with him the best method of training children…

If you haven’t picked up this book, I suggest you do. It will be one of the best investments in seeking wisdom you would ever make.

* * *

Ryan Holiday writes about how Roman emperor Marcus Aurelius conquered stress, and the rest of us can too –

By taking the time to journal and write, he was chipping away at his anxiety, just as we all can – in the morning, at night, on our lunch break. Whenever.

To calm his anxiety, Marcus was also constantly trying to get perspective. Sometimes he zoomed way out. He meditated on his insignificance. “The infinity of past and future gapes before us,” he wrote, “a chasm whose depths we cannot see. So it would take an idiot to feel self-importance or distress.”

Other times, he zoomed way in, telling himself to take things step by step, moment by moment. No one can stop you from that, he said. Concentrate like a Roman, he said, on what’s in front of you like it’s the last thing you’re doing in your life.

Don’t worry about what’s happened in the past or what might happen in the future.

This idea of being present is key to overcoming our stress.

We are often anxious because of what we fear will happen next, or after what happens next. We worry about worst case scenarios. We dread potential obstacles. But Marcus, from Epictetus, knew that “Man is not worried by real problems so much as by his imagined anxieties about real problems.”

* * *

That’s about it from me for today.

If you liked this post, please share with others on WhatsApp, Twitter, or just email them the link to this post.

With respect,
— Vishal





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