The skills required to become a successful investor can be hard to pin down, even though some brokerage ads imply that a combination of data and low commissions is pretty much all you need. Low commission rates—like those our clients enjoy—are easy enough to find, but it takes more than an “app” and a clever commercial to invest successfully.
In his essay, “Insight” (in the book, Thinking, edited by John Brockman), Dr. Gary Klein discusses how success at complex pursuits—including investing—requires two types of thinking: what he refers to as “explicit” knowledge and “tacit” knowledge. Explicit knowledge is comprised of facts, procedures, checklists and the like. This is the kind of knowledge that can be conveyed in words—the part that can be taught, if you will. In contrast, tacit knowledge can only be developed from years of relevant experience. This is the adaptive insight that’s very difficult to reduce to words or procedures; insight that seems to come out of nowhere, but actually springs from experience. Dr. Klein calls this “intuition.”
Tacit knowledge—intuition derived from experience—is essential to investment success for several reasons. First, experience enables an investor to become skilled at recognizing patterns many others fail to see, which in turn leads to an ability to better evaluate investment situations and form reasonable outlooks. If an investment situation intuitively “feels” wrong, the investor can be alerted to watch for hidden pitfalls and avoid some unpleasant surprises. Second, an expert uses intuition to make perceptual discriminations that are essentially invisible to others. To use Dr. Klein’s example, most casual viewers cannot perceive—in real time—the difference in splash between a diver entering the water perfectly and one entering with her feet slightly separated. Only during the instant replay do we non-divers perceive what the experienced commentator brings to our attention. An expert, however, instantly sees the difference. Third, experience leads to a recognition of “typicality,” and when you know what’s typical, an anomaly stands out like a sore thumb (and gets further attention). Finally, experience allows an investor to build mental models of how things work. Inexperienced investors substitute guesswork for useful mental models, and this rarely leads to success.
Dr. Klein’s examples in his essay are not primarily drawn from investing, but the concepts apply nonetheless. At J. V. Bruni and Company, we are by no means lacking in data and procedures—explicit knowledge, in other words. We use them extensively. Beyond that, however, we bring tacit knowledge—intuition developed during many years of experience—to every investment decision we make. Pattern recognition, perceptual discrimination, an understanding of typicality and mental models all contribute to our success. Intuition has been wrongly discounted as airy-fairy and unimportant because, to quote Dr. Klein, “…it doesn’t involve declarative knowledge about facts. Therefore, we can’t explicitly trace the origins of our intuitive judgments. They come from other parts of our knowing … Intuition sometimes feels like we have ESP, but it isn’t magical—it’s really a consequence of the experience we’ve built up.” In short, as we did in 2009, we always draw on our experience—however it’s labeled—to benefit our work.