Investment Learning from the Law

I went to law school on account of certain skills I possessed – some general academic talent, analytical and writing skills, the ability to marshal arguments, and very good standardized test-taking ability. But I didn’t really understand what attorneys did in any meaningful sense.  Indeed, I had never met one before enrolling in law school at Duke.

As it turned out, I became a pretty good attorney – my skill set was appropriate.  But I never liked it very much and I was better suited for this business.  I favor accommodation, collegiality and collaboration to conflict. I’m better at big picture trends and goals than I am at minute details. I prefer adding value to playing zero sum games. I have a much shorter attention span than the litigation process permits. So I now refer to myself often as a recovering attorney.

But my legal training has helped me in this business in a number of clearly definable ways. Indeed, law school provided a pretty good education for a budding investment professional. I outline five specific and interrelated investment lessons I’ve learned from my legal training and experience below.

1. Think probabilistically. The vast majority of civil cases are decided based upon the greater weight of the evidence. That means that the side with the better evidence and arguments wins (and in the event of a tie, the party with the burden of persuasion loses). In other words, 50.1 percent probability is enough to win. The law recognizes that certainty is elusive at best.  We don’t need to be 100 percent sure. Instead, we need to make our best judgments and go with the better evidence and arguments. We aren’t going to be certain. Often we won’t even be sure. But the tiniest bit better – the most probable result – should generally be enough to carry the day. It’s surely the best place to start. Investors never have reason to be certain. There are so many variables involved in the markets that reasonable probability is the best we can hope for. Attorneys get that.  We should too.
2. Learn to argue the other side. A remarkable universe of discoveries in psychology and neuroscience demonstrate that our preexisting beliefs skew our thoughts and even color what we consider our most dispassionate and reasoned conclusions. Expecting people (including ourselves) to be convinced by the facts is contrary to, well, the facts.  Factor in our behavioral biases (such as the ever popular confirmation bias, optimism bias, in-group bias and self-serving bias) and it’s easy to see (at least conceptually) why we can get it so wrong so readily.  Our tendency is to look for and consider only those views that correspond to our own – which goes a long way towards explaining the popularity of Fox News and MSNBC, for example, while also explaining why the viewers of each of those networks tend to think that only the other side is nuts.  If we are going to be able to see things a bit differently, we need to seek out and consider sources that look at things differently.  Since attorneys are paid to take a particular side and are evaluated based upon how well that side is represented, “motivated reasoning” is a particular problem.  That’s why the best attorneys work at understanding and even learning to argue the other side’s case.  Bad lawyers run around looking for anything and everything that may help their cases and for stuff that might damage the opposition to the exclusion of everything else. The best attorneys recognize that examining, understanding and even appreciating contrary evidence is helpful to their own thinking and can provide a good check on the coherence of their positions. Understanding the opposition’s best evidence and seeking support for its best arguments is a powerful learning tool and one investors should emulate.  We might even decide that – gasp – mistakes were made (almost surely by someone else, of course).
3. It’s all about the evidence.  In a legal action, it’s all about the evidence.  While juries are sometimes bamboozled by a good story or prejudiced by bias, judges are charged with dismissing even powerful cases when the evidence is insufficient. The entire legal process is focused upon gathering, evaluating and presenting good evidence.  There are careful and detailed rules for deciding whether proffered evidence should be deemed evidence at all and whether it can and should be admitted for consideration by the appropriate finder of fact.  As investors, we should focus on the evidence in a similar way.  As I have stressed repeatedly (and I’m not alone in this), it is crucial for investors to focus on the available data and always to be seeking more and better data. We should always strive for a data-driven perspective and a data-driven process.   That isn’t easy to do, sadly.  We relate better to stories and are all too willing to believe and concoct narratives of various sorts to support our latest nonsense, but it’s a worthy aspiration and commitment nonetheless.  As W. Edwards Deming (who Barry Ritholtz wrote about this week-end), perhaps the original data scientist, famously emphasized: “In God we trust; all others must bring data.”
4. The evidence must be evaluated and presented analytically.  Attorneys need to gather evidence with great care and then evaluate that evidence with great care because judges are called upon to rule on the admissibility of every piece of it.  Because our tendencies toward behavioral and cognitive biases as well as toward misused and misapplied heuristics, we must similarly analyze our investment evidence.  As I repeatedly point out (see my masthead), information is cheap while meaning is expensive.  Accordingly, we need to evaluate the evidence properly in order to figure out what it means and how it can be applied successfully and effectively. One of my reasons for consistent publication via this blog and otherwise is that it offers a terrific commitment device. Wishy-washiness simply won’t cut it. Moreover, since my mistakes and failings are public, I have to face them head-on. Accordingly, it is crucial that I get to publication with great care. Attorneys recognize that need well, as their positions must be presented formally and in writing at every level to be scrutinized and challenged by the opposition.  Possessing evidence that might look good isn’t enough.  It needs to be presented effectively to make a difference.  Part of that is stylistic. It needs to be presented persuasively. But even more importantly, it needs to be presented within an analytical framework that makes sense. Style doesn’t matter if it isn’t supported by substance. “Writing it up” is never a bad idea.
5. Check and re-check your work.  Good attorneys check and re-check their work and their evidence. In big cases they even bring in good attorneys from outside to take a look at their files and help them look for holes in the evidence or weaknesses in their arguments. Similarly, we need (relative) objectivity if we are going to succeed in investing and in life unless we are extremely lucky. Having an accountability partner or (better yet) a competent and empowered team is particularly important due to our great ability to spot what’s wrong with everybody else (if not ourselves, due to bias blindness). It also means taking and dealing with criticism seriously – even welcoming and encouraging it.  It shouldn’t be surprising to see so many people who experience great investment success suffer indifferent performance or even failure subsequently (Bill Miller and John Paulson, for example).  The more success and power we achieve, the easier it is for us to believe the hype. Accountability mechanisms that are maintained and honored can help to undercut that.  No matter how good our process is, we need also to assume that we have made errors and set out actively to find them by testing and confirming everything possible. Once we have decided that a given view is correct or commit to a particular course, confirmation bias has a tendency to take over.  Planning to be lucky and believing that psychological realities don’t apply to us is a lovely (if arrogant) thought.  But it’s not remotely realistic.  If you want to succeed, keep testing and looking for ways that you’re wrong…and make sure that you have help.  Investors of all sorts would benefit from making careful presentations of their conclusions and proposed investments to skeptical colleagues in order for them to challenge their thinking and their conclusions. As the adage suggests, measure twice, cut once. But in the investment world, twice may not be enough. Even better, let somebody else do some of the measuring.

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