You can broadly categorize all games into two types: dynamic and static.
I use “games” in the broader/more general sense that includes things like business, investing, school, etc.
Static games are games where the actions and outcomes of one player do not affect the actions and impact of another player.
Schooling is generally a static game. Just because someone else got an A on a test, does not make it any more or less likely that you will get an A.
Dynamic games are pretty much everything else in life. Markets are maybe the best example.
If one investor buys something, the price tends to go up. That means if you buy it after them, you cannot get the same outcome: their buying increased the price.
It is common for trades to become crowded: if one particular trading style or asset class is doing well then more people rush into it which makes it less profitable for everyone currently doing.
I think one of the most significant mistakes that people make is that they tend to play dynamic games as if they are static.
Anytime someone says “This worked in the past so I am going to do it as it will work in the future” then they are typically basing that on some assumption of static-ness.
One reason we tend to treat things as static games is probably that the game most of us growing up play (school) is static.
Another reason is probably that it is much easier to understand a static game than a dynamic one and it’s tempting to over-simplify.
I call this tendency the Maginot Line Problem. The Maginot Line was a line of concrete fortifications, obstacles and weapons built by France in the 1930s to deter invasion by Germany.
However, the French learned the lesson of the First World War much too literally: they looked at where the Germans invaded and built a big wall there.
They had a static response to a dynamic game. The Germans didn’t try to invade in the exact same way. They realized there was a big wall there and they went around it.
One important implication from this as it relates to investing your time and money is that unknown and unknowable situations have been and will be associated with remarkably powerful investment returns.
By definition, if one wants to perform better than average, you can’t do what the average person does.
Criteria for the best investments tend to be:
- High levels of uncertainty
- Some barriers to entry – often in the form of high frictions and difficulty of executing the trade
- Some competitive advantage – you know something that the other side does not, some specific/local knowledge.
The presence of these three things are necessary, but not sufficient. It’s possible for some opportunity to have all these qualities and still be a poor investment.
It’s important to realize that these things tend to be cyclical. Many people read the book Rich Dad, Poor Dad and think that Real Estate Investing is the best thing since sliced bread.
The real lesson from Rich Dad, Poor Dad is that he was investing in a market (U.S. residential real estate) in the 1980s and it wasn’t professionalized and institutionalized until the late 90s (with a big acceleration following 2008).
That’s not to say you can not make money investing in real estate, but it’s a whole lot harder than it was in the 1980s.
Michael Marcus, one of the great trend following commodity traders of the 1970s related his experience when he started trading commodities futures in the early 1970s.
In those days, you watched the board, and you would buy corn when it moved above a key chart point. An hour later the grain elevator operator would get a call from his broker and he might buy.
The next day, the brokerage house would recommend the trade, pushing the market up some more. On the third day, we would get short covering from the people that were wrong, and then some fresh buying from the dentists of the world, who finally got the word that it was the right time to buy.
At that time, I was one of the first ones to buy because I was one of the few professional traders playing the game. I would wind up selling out to the dentists several days later.
As a rough rule of thumb, if your counterparty is a dentist on their lunch break, then your odds are probably pretty decent. (No offense to the dentists. As a counterpoint, the largest landlord in Los Angeles is a dentist that started buy real estate in his spare time in the 1980s so good to remember that rules of thumb are just that).
I tend to think of different opportunities as having epochs. If you wanted to start an oil company, the right time to do that was about 1870 when Rockefeller started Standard Oil.
If you wanted to start a Search Engine, the right time was about 1999 when Sergey and Larry started Google.
As Peter Thiel explains it, “every moment in business happens only once. The next Bill Gates will not build an operating system. The next Larry Page or Sergey Brin won’t make a search engine. And the next Mark Zuckerberg won’t create a social network. If you are copying these guys, you aren’t learning from them.”
In the case of a test, the more people that you talk with who have all arrived at the same answer to question #2, the more likely it is that is the answer.
In the case of an investment, the more people you talk with who have all decided that an investment is a good idea, the worse your potential outcome gets.
It’s valuable to read broadly in a field is that when you first get into something, you tend to fall into the Maginot Line Problem.
Only after you’ve had a bit of experience and surveyed the field can you start to get a sense of what the more general principles are. They are often the illegible ones that are whispered rather than said out loud.
Acknowledgements: For a thoughtful read on the topic, check out Richard Zeckhauser’s paper: Investing in the Unknown and Unknowable.
Last Updated on June 14, 2021 by Taylor Pearson