Please find our summary of this brilliant lecture of Mr. Bakshi hosted by Flame University.
The first idea that Professor Bakshi talks about is, the concepts that were taught to us in school were really important concepts but because we were not really able to contextualise it we forgot the concepts with time. The biggest learning would involve understanding the context behind all those concepts.
The second idea that he speaks about is application. You need to constantly apply those ideas which you learn. Naval Ravikant also says that if you don’t have the intention to use that particular information; don’t listen to that information. The mindset of application is essential to learning anything.
You have to be a multidisciplinary thinker to be able to understand the complex concepts at work. The ideas are really a mixture of understanding multiple disciplines. Just learn the most important ideas from every discipline.
The ideas from multidisciplinary subjects usually give birth to stunning outcomes; to what Charlie Munger says lollapalooza effect.
The first idea that he talks about is Compound Interest. Compound interest is referred to as the 8th wonder of the world. The formulae has three critical components; Principal, Rate of Return, Number of years. All the three components allow you to build sufficient wealth over the years.
Let’s take an example; if I start investing at the Age of 20 and keep on investing every month until 35, on the other hand if I start investing at the age of 35 and invest till the age of 40, who has the better chance of generating more wealth? the former one right? On the other hand if I get a rate of return of 10% for 30 years and my friend gets a rate of return of 14% for 30 years; that difference of 4% could lead to a staggering difference because of the phenomenon of compound interest.
Professor Bakshi also talks about delayed gratification. If we continue to withdraw our invested amounts on a consistent basis than what we will get is simple interest and not compound interest. So he wants us to exercise this habit of delayed gratification so that each penny which is invested gives you the benefit of compound interest.
The idea of compound interest is not only applicable in investing but also applicable in all other facets of life. To develop knowledge we need to read and understand something; it required reading a little daily so that after a period of time this strong pool of knowledge develops. Charlie Munger has rightly said that I want to go to bed smarter than I woke up in the morning.
Professor Bakshi talks about the book named “The Marshmallow Test” which talks about the phenomenon of delayed gratification. The book showcases an experiment wherein a child is asked to sit in a room alone with a Marshmallow and is given a choice to either eat it or wait for 15 minutes to get another marshmallow. The test was basically trying to understand whether a child can exercise that will power. If a child is able to exercise that will power it means that he/she has the foundations to practice delayed gratification.
He gives a life lesson when he says that every decision you take will involve a trade-off. In investing terms, every dime spent right now costs you the opportunity to earn more on that dime later. He talks about the concept of frugality; he says if my spending involves wastefully buying things that when accumulated over longer periods of time has basically taken the freedom from him to invest in the things that are more meaningful.
The aspect of frugality can be applied to other aspects of life too; if I don’t save on expenses that I don’t need I might miss the opportunity to invest in things that are good for me in the long term.
He says that it is very important to start early whether it is investing or health or basically any other aspect of life that you want perfection in. If you start early you give yourself the benefit of time to compound your earnings; as buffet says it will act as a snowball effect.
He talks about a trade-off between R and N. People normally run after higher R and sacrifice the N. The higher R which can be beneficial in the short run can lead to disastrous consequences in the longer run. The long run requires the N to grow continuously and a little lower R won’t really do much damage. This aspect can be applied to other aspects of life too; if I focus on higher R which means a willingness to reward the present it can lead to sacrifice of the time which could have been spent in reading books or other skills that you want to learn.
Life is basically a trade off between short term and long term. If we are gambling for higher returns, you might get higher R but if you lose money in that attempt than it will not allow you the scope to go for N.
He talks about another author named Daniel Coyle; he talks about his book in which he says that every athlete whether a cricketer, a chess player, a martial arts professional, etc, all focused on “Repetition”. The author says Repetition is the most underrated. He gives the example of Bruce lee; Bruce lee once said that I don’t fear the person who has practiced 10000 kicks once but a person who has practiced one kick 10000 times. He says compound interest follows the philosophy of “No pain No Gain”.
The second idea that professor Bakshi talks about is “proof by contradiction”. Proof by contradiction means that you assume that the idea is true and try to understand the premises behind the ideas and through understanding the premises you basically contradict the idea itself.
He gives two examples; the first example is by buffet where he talks about the dotcom bubble, he says that if the valuations that this dotcoms are quoting are true than the company has to earn this much amount of money to basically justify that valuation but the people are not really using those products at that level which means that the valuation in the end is not justified. Another example that he gives is of Harry Markopolos; Harry markopolos uncovers the Bernie Madoff scam by applying the same concept of proof by contradiction.
Another idea that he talks about is falsification. Falsification is basically disproving things until you reach the thing which seems to be true. He gives the example of Sherlock holmes who uses the same concept of falsification to solve problems, Mathematicians have been solving the problems through disproving since time immemorial.
Professor Bakshi combines the idea of Reductionism and proof by contradiction and explains the example of Suzlon. Before we look into the example let’s first understand Reductionism; reductionism is a concept which involves reducing the complex problems into simpler one.
Reductionism is basically reducing the problem into the most fundamental problem of a particular discipline. Now when we get back to the example of suzlon we find that the company’s valuation was trading at so and so number and by applying proof of contradiction we first accept the valuation and then try to understand whether the financial statements justify those valuations.
Bakshi sir applied the model of physics (Reductionism) in order to understand the problem; he says we don’t have the physical space to build so many windmills which the valuations are indicating and hence the valuations of the company don’t seem justified.
Professor Bakshi talks about the problem of inversion. He gives an example to understand inversion better; he says if you want to lead a successful life first find out ways how a person can fail and make a list of it, once you make a list of it just avoid the things that are on the list. It’s the same in investing too, try to find out how a business can fail and just avoid buying businesses that do those things.
Just identify dumb behaviour and avoid it.
He talks about another idea by the name of smaller probabilities and larger consequences. He says in school we talk about objective probabilities and not subjective probabilities, but in life there are more subjective probabilities. Another thing they don’t touch you is the power of consequences.
He takes the example that if there is heads than you will be paid 50 lakhs but if it is a tail you will lose 10 Lakhs, would you take the bet? Most of the people said no. What do you think would be the reason for this? The reason could be that even though on expected value terms I am gaining I won’t take the bet still because there is an equal chance to lose money too.
He gives another example that if there is a 20 percent chance of a total wipe out would you take the bet? Again many people said no. It is because even though the chances of wipe out is less still wipe out is a consequential event and no one would want to take a chance.
He quotes Nassim Taleb where Taleb says that “It is irrational to separate risk taking from the risk management of ruin”.
Professor Bakshi says that if you do an improbable thing over and over again you in a way allow yourself to be the victim of that outcome. He gives the example of fraud and crime in which he says that the risk of getting caught maybe less but every time you do it you just have to be unlucky once to get caught so the risk of getting caught increases if you keep on doing the improbable.
Another Idea that Professor Bakshi talks about is “Don’t be a patsy in the game”. He gives an example of a coin toss and says that there is a 50 percent chance of coin landing as a head or a tail but when the coin toss actually happens, out of 99 times the coin was tossed, it was the Head each time, so a question is asked will there be a tail when the coin is tossed for the 100th time? To which the answer will still be 50%. The outcome of a coin toss doesn’t have a bearing on another outcome, they both are independent events. Don’t see a relation where none exists.
One of the key assumptions in the example was that “The coin is Fair”. Is it right to say that the coin is fair if 99/100 times the coin toss gives the outcome of head. Buffet says that you are being manipulated all the time in investing world, it is important to question everything. He says if in 30 minutes in a poker game you are not able to identify the patsy, you are the patsy.
Professor Bakshi talks about how important it is to think like a statistician; he gives an example wherein a plane has come back from the war and there have been holes on it so the US military decided to put an Armour on those parts where there were holes but a statistician was called and he gave a totally different conclusion that put an Armour on the sides which are not damaged. One of the key reasons behind the conclusion was “Survivor-ship bias”, which means that we only focus on things which survived.
In the example what if the parts that were shot were resilient and they were able to come back and what if those who didn’t come back were shot on those parts which appear to have not been harmed. Survivor-ship bias is the most common error we see in the world, that’s why it is important to think like a statistician.
The last idea that he talks about is Bayes theorem. Bayes theorem as given by Daniel Kahneman is, Posterior odds= Prior odds multiplied by Likelihood ratio. Bayes theorem in simple language is a way to either to change your beliefs or a way to reinforce your current beliefs.
He gives an example of a person named Tom who is considered as shy by his classmates, they are asked given that Tom is shy how likely is it that he is a Math PHD or in a business school, they answered Maths PHD, which might be correct, but they forgot to ask a basic question that how many maths phd programmes are offered as compared to business programmes and the answer is comparatively very few. So with this new information the probability suddenly changes and we have a new probability if we account for both the information.
The key thing to take away is that always keep revisiting your beliefs and if needed change it.