Tuesday, October 6, 2009 10 comments ++[ CLICK TO COMMENT ]++

The Michael Jordan Way - Does deliberate practice lead to success?

The author at the Distressed Debt Investing blog wondered a few weeks ago if continuous practice is the way to achieve investment success. I was going to link to his thought in one of my 'links' posts but, after thinking about it for a while, I thought I would expand on the thought and write a standalone piece.

The author at Distressed Debt Investing cites several books that tackle what it takes to become successful. For those too lazy to read and would prefer an essay critiquing the thoughts :), you might want to check out the excellent essay written by Sue Halpern for The New York Review of Books (I linked to this before so you may be aware of it already.) Regardless of whether you agree with Malcolm Gladwell, or Geoff Colvin, or Sue Halpern—all three have differing views—one thing is hard to dispute: there appears to be many activities where chance of success is boosted by deliberate practice. Distressed Debt Investing cites the story of Tiger Woods, who supposedly had been practicing golf, or activities resembling it, since he was a kid. The example I like to think of, and one that is more relevant for investing, is Michael Jordan.

Michael Jordan & Meticulous Practice

Michael Jordan is arguably one of the top basketball players of all time—if not the best, he is the 2nd best after Wilt Chamberlain IMO. A lot of people think Jordan was good because of his physical skills and his talent. No doubt you need a minimum amount of skill but there is more to it. After all, there are many other players who are far more skilled—faster, have higher verticals (how high you can jump), much stronger, much smarter—yet don't have numbers anything like him. I mean, even one of the my favourite players, and generally liked by most Torontonians (until a few years ago,) Vince Carter, is athletically superior to Jordan.

I believe a lot of Jordan's success can be attributed to his hard work—deliberate practice if you will. I came to this conclusion a long time ago after hearing the story of Jordan and his free-throw practices. Unlike many other basketball players, Jordan supposedly kept practicing his free-three shooting well after the practice was over. The story, as I heard it, had Jordan often being the last person to leave.

Jordan's story is similar to how Peyton Manning, a highly rated quarterback in the NFL, is famous for watching a lot of videotapes. Peyton Manning probably watches more tapes of opposing teams in an year than an average NFL player does in 10 years (I'm just speculating here, but based on some articles I have read, that is probably correct.)

So I think greats do improve their success by deliberately trying to hone their skills. We can never be sure but it is probable that neither Peyton Manning nor Michael Jordan would be that good if they didn't watch videotapes of opposing players or continuously practice free-throw shooting, respectively.

I picked the sports examples because it is counter to most people's thinking. My impression is that many believe you can improve, say, your essay-writing skills or mathematics by practicing over and over, but many would argue that sports is based on innate or physical talent. Yet, the fact that Jordan and Manning, two of the top players in the modern era, repeatedly pursue select activities implies that you can improve yourself. Yes, there is some minimal requirement but practice pushes you into the realm of the Great.

I think we can learn something from Jordan's free-throw scenario so let's think about this for a minute. This example ties nicely into my opinion of investing.

Jordan's Free Throw Shooting

Instead of all the players with horrible free-throw shooting staying late—say those shooting 50% in playoffs ;)—and trying to improve their game, we had one of the top free-throw shooters in history continuously trying to improve his shooting well after practice was over. Jordan, according to basketball-reference.com, was the 76th best free-throw shooter in the history of basketball (in terms of career FT%.) He was very good, but not spectacular, in free-throw shooting (i.e. he is not in the top 10 of all-time in free-throw shooting accuracy.)

Micheal Jordan's FT% may not look important given that he isn't in the top 10 of all-time but it is very critical to him. It just doesn't appear that way.

Jordan also happens to have attempted 8772 free throws in his career. This places him 9th on the all-time list for free-throw attempts. This shouldn't be surprising to any basketball fan because it simply shows that Jordan gets fouled far more than a regular player. Why is this important?

The fact that Jordan gets so many free-throw attempts means that he can score more points if his free-throw percentage was higher. In fact, without being an expert on basketball, I would argue that Jordan would have been a much worse player—not terrible but not spectacular either—if his free-throw percentage was lower. This is pure speculation on my part, since who knows how he would have actually performed if he sucked at free-throws, but I think it's a reasonable guess.

So, to sum up, even if you think it is hard to be a successful basketball player without the physical skills—it does require some minimal talent—you have to admit that Michael Jordan's continuous practicing of free throws must have contributed greatly.

Is This a Sports Blog or an Investing Blog?

I'm actually not into sports as much as most men are. I picked the sports examples deliberately because it shares some elements with investing. At least I think so.

Going back to the original thought brought up by Distressed Debt Investing (i.e. does deliberate practice lead to investment success), my view, as an amateur investor, is as follows. My investment record is poor and I don't have much experience but sometimes outsiders sitting on the sidelines have greater insight than those on the field.

Distressed Debt Investing suggests that mastering a particular area, by continuously practicing, is perhaps the way to go. I think the answer depends on the investment strategy one is pursuing. I think there are investment strategies where practice probably doesn't help much; and there are areas wher it helps a lot. The ultimate benefit comes down to how close you are to Michael Jordan's free-throw scenario.

Where It Probably Works

My feeling is that deliberate practice probably has the biggest positive impact in cases where you are shooting free throws. If you get a ton of opportunities and if the risk of failure is tolerable, practice probably makes a huge difference.

An example in my mind of something resembling free throws in basketball is risk arbitrage (as a side note, a lot of value investors, ranging from Warren Buffett to Benjamin Graham to Edward Lampert, started out in risk arbitrage so it's a good strategy for newbies.) Risk arbitrage presents you with many, many, opportunities that are sort of repetitious. I suspect that deliberate practice will make you a better investor. I'm a total newbie with a dubious record but I can say for certain that I have improved significantly since my first risk arbitrage deal.

Investors who have a small circle of competence—either because they are incapable of expanding it or because they don't have time to expand it (especially if you are an amateur doing this on the side)—will probably benefit from deliberate practice as well. If your circle of competence is narrow, it means you only encounter a few industries and a limited number of companies. Repeatedly analyzing similar companies probably gives you an advantage.

I don't know anything about trading but I suspect traders can get better by repeatedly practicing as well. The same thing probably applies to quantitative investors (but I don't know anything about what quants do or what the theory underpinning their work is.)

People who follow some of Benjamin Graham's strategies will probably boost their performance by putting in a lot of hours. My impression of Graham-type value investors is that they are very numbers-oriented, with the numbers coming from the financial statements. I think if you put in a lot of time in financial statement analysis, you will probably recognize patterns. At a minimum, you can instantly rule out companies based on their historical financials.

Certain areas that resemble "trading" more so than "investing" probably benefit from repeatedly practicing. My impression is that those involved in currencies and (low-risk) government bonds probably fit this description.

Where It Probably Does Not Work

My opinion is that deliberate practice probably does not help much with macro investing. Doing something is better than doing nothing but I'm not sure the pay-off is that likely. I say this because a lot of macro strategies seem to depend on low-probability events or scenarios that don't have much of sample size. You just don't get enough chances to practice.

For instance, let's say you believe in the commodity super-cycle thesis. How the hell do you practice that? Such a cycle, if it were true, comes around once every 25 years or so. Same with, say, a contrarian that blindly bets on Japan just because it has been in a 19 year bear market. Or how about someone that believes oil prices will go up for decades? How about those betting on deflation? You had three deflation data points in the last 80 years or so (1930's USA; 1990's Japan; and maybe 2000's USA).

How about someone that believes US Treasury bonds will enter a major bear market (i.e. interest rates will rise for decades)? These cycles are so long that you may get one chance to predict a particular outcome in your whole life.

I'm oversimplifying a bit here, since macro trends, which tend to last for years, presents you with several entry points. However, I think you really only get one chance, generally early on, or else the timing can be difficult resulting it huge losses and possibly throw you off your game. For instance, someone who believes in the commodity supercycle theory could have taken a position any point in the last 10 years or so (depending on the commodity) and can probably be certain of making money (assuming the supercycle thesis actually plays out.) However, anyone investing in the last 2 or 3 years would have great difficulty surviving the spectacular declines.

You just can't practice any of these macro-type investments. All you can do in these cases is to study history or current events, or whatever, and wait. I remember Hugh Hendry saying that he spends a lot of time just going to the park and just reading and doing nothing.


Although this goes somewhat counter to popular opinion of how Warren Buffett actually behaves, my opinion is that deliberate practice probably doesn't help Buffett-type investors that much. Buffett continuously studies annual reports, news events, and so forth. But I don't believe that is what really matters. Instead, I think, as I alluded to in my recent post about Munger, what matters is seizing the moment. Buffett has studied countless companies and has been investing since he was a kid but I would argue that he hasn't had much practice. However, from my limited knowledge of Warren Buffett—Buffett fans reading this should correct me if I'm wrong—there is nothing to indicate that he deliberately practiced investing.

I don't know the actual record but I would guess that Buffett has made fewer transactions in his 50+ years of professional investing than many professional mutual fund managers have done in ten years. This shouldn't be a surprise because Warren Buffett is largely a concentrated investor. Therefore, I really don't think he "practices" much. (BTW, I'm not counting thinking or contemplating as being equivalent to practicing. As anyone that has invested real money knows, there is a huge difference between thinking about an investment and actually investing—in particular, you won't feel greed & fear, which are central to any investing.)

So, I think Buffett-type investors, particularly concentrated investors, probably don't gain much from practice. You just don't get enough chances to practice hence you can't rely on it.

Recap

To answer the original question of whether deliberate practice helps investing, I think the answer depends on the type of investor you are. Just to be clear, I do not consider reading or thinking about investments as practicing. I think all investors should be continuously involved and gainining knowledge at all times. The question to me is whether someone actually goes out there and does something (i.e. practices with an actual portfolio.)

My feeling is that investors following some strategy that can be repeated many times with low downside will likely improve themselves with practice. Traders are a good example of this. A trader who transacts 100 times an year will probably be getting better whereas I think a Buffett-type investor who buys/sells 100 assets probably isn't gaining much.

I think one needs to figure out where they stand and see if practicing would help. Some practice using fake portfolios but I have found that kind of useless. The problem with fake portfolios is that half of investing is psychology and you won't be exposed to that. Until you start panicking because your investment got blown up; or feel like investing your whole life savings because the stock keeps going up, you really haven't learned much.

As for me, I'm pursuing a concentrated portfolio and trying to be more of a Buffett-type investor (while retaining a strong macro influence,) I don't think practicing helps. Most of the stuff I look at comes around once ever 5 years or whatever. It's hard to practice for something that occurs infrequently, and often totally out of the blue. For example, long time readers may recall my interest in junk bonds late last year and early this year. Such a situation rarely comes and it's hard to prepare for that. It's possible that my biggest mistake of the last few years (not counting Ambac) is missing the chance to capitalize on that. Although bonds may come under pressure again—say if defaults keep rising or CLOs blow up and cause liquidity problems elsewhere—I think I missed out on that. I just don't think you can gain much advantage practicing for such scenarios.

Ultimately it comes down to whether you are a shark that continuously swims around trying to catch fish; or whether you are a tiger that sits silently beside the long reeds for hours ready to pounce. I think the shark will gain much from practicing but the tiger, not so much.

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10 Response to The Michael Jordan Way - Does deliberate practice lead to success?

PlanMaestro
October 7, 2009 at 1:02 AM

In investing you can learn from others and build a body of knowledge. It is scientific in the Popperian sense. In sports, your own muscles have to go through the trial and error process.

Reading other investors decisions and going through hundred of annual reports builds a database of cases. If you are disciplined you can systemethized what worked, when it worked, what were the circumnstances. You can also play simulate, in what conditions it would not work. And if you are a maniac you build checklists and adapt them over time.

Sivaram Velauthapillai
October 7, 2009 at 10:14 PM

There is some element where a scientific approach, as you suggest, will work. You also need a minimum amount of knowledge and effort. However, I think it depends on the investing strategy. I think it is less useful for macro-type investors.

For instance, consider your investment in distressed shipping companies. I will argue that there is no way you could have prepared for what happened. Even right now, you may be looking at a once-in-a-20-year scenario.

In other words, someone who has been investing for 5 years (assuming a minimum amount of knowledge, effort, and skill) is probably no worse off than one studying the market for 20 years (in these circumstances.) I know that sounds crazy and counter to what most people say but think about it. Who are the ones that have been decimated by the collapse in shipping? It is actually ones that have been in the industry for a long time and know a lot about it. Look at all those owners/managers who ordered so many ships in the last few years. Similarly, look at the shareholders who financed those owners/managers in the last few years.

Overall I agree wtih you that something like a checklist can help. But ultimate success depends on the strategy IMO.


(BTW, your new blog is great. I haven't had much time to check it out or comment on it--hunting for a job in case my company runs into problems :( --but keep up the good work.)

PlanMaestro
October 8, 2009 at 12:26 PM

Thanks Man, I will try to keep the creative juices flowing.

All major investors have a similar advice, even macro traders: Read History. However I have to give it to you, Tudor Jones is of the opinion that leaving in the 70s and having a baptism by fire on the extremes that markets can go, and survive it, is a competitive advantage.

http://variantperceptions.wordpress.com/2009/09/25/alpha-magazine-hall-of-fame-%E2%80%93-the-traders/

PlanMaestro
October 8, 2009 at 12:30 PM

Thanks man, I will try to keep the creative juices flowing. And good luck with your company.

<span>All major investors have a similar advice, even macro traders: Read History. However, I have to give it to you, Tudor Jones is of the opinion that living in the 70s and having a baptism by fire on the extremes that markets can go, and surviving and prosper in it, is a competitive advantage.
 
http://variantperceptions.wordpress.com/2009/09/25/alpha-magazine-hall-of-fame-%E2%80%93-the-traders/</span>

MrParkerBohn
October 9, 2009 at 6:52 AM

Interesting post and comments.

It is a matter of definition whether there is any difference between practice & experience.  You seem to draw a distinction, saying that Buffett receives very little practice, whereas it seems pretty clear that Buffett has a huge advantage due to his long and deep experience (as well as of course his temperment, corporate structure, and personal brand).

So it seems to me that for investment, it is more a matter of experience than of practice.

I certainly feel that I have gotten better with experience.  I average only 1 or 2 transactions per month, so most of my experience comes from reading and researching and analyzing financial statements.

However, I think there are times when having too much experience can be a trap for an investor.

Someone with lots of experience can become overconfident.  For instance Bill Miller, who is a very good investor who beat the S&P for 15 years in a row, destroyed 10 years of that outperformance by repeatedly doubling down on bad investments such as Fannie Mae.

It is even possible that all his logic and numbers were correct (ie Fannie Mae was a good and correct bet), but that his long experience of being right caused him to underestimate the risk.

Someone with 20 years of investment experience may feel like a veteran who's 'seen it all', but their entire investing career could have taken place during a single long-term secular trend.

This is particularly true of specialists who become experts in one field, whether its bond trading, insurance, shipping (as mentioned above), or any other field.  Each of these specialists is going to have WAY more experience (practice?) in their field than any of us will ever have, but they may still be caught with their pants down when the world changes, or a black (or even grey) swan comes along.

My strategy is to become merely reasonably decent at valuing a broad number of different assets and industries, and then try to stay alert.

Sivaram Velauthapillai
October 10, 2009 at 5:06 PM

First of all, let me be clear in saying that a minimum level of knowledge and skill is required. Obviously someone who was never experienced to finance (say, never studied it in university; never read a book on it before; etc) will need to spend quite some time getting up to speed. Beyond that, I wonder if experience matters for some strategies.

The thing is, I believe that certain investment strategies depend on capitalizing on specific opportunities rather than experience gained from deep study.

Let's look at Warren Buffett. Most people think of his success in the last 30 years, which quite frankly is nowhere near his superinvestor phase before that. Buffett, although very studious and lots of knowledge, made very good investments early in his life (say after he graduated from school). An example is American Express in the 60's. Although experience surely helped, I don't think that is what mattered when Buffett was investing in the 1960's. Instead, it's the ability to capitalize on that opportunity at that specific point of time.

I honestly don't think it would have mattered if you had 30 years of experience when looking at Amex during the salad oil scandal. Some guy with 2 years of experience (and some minimum skill) is probably no worse off than someone with 30 years.

P. W. Dunn
January 3, 2010 at 8:00 PM

I enjoyed reading your reflexions.  I think the difference between Carter and Jordan is not so much one of talent as it is intensity, drive and endurance.  Jordan had all of these in spades, while Carter has never had as much.  But perhaps you are also comparing young Carter during the Toronto years, with the late Chicago championship Jordan, the older less athletic player that relied on tenacity, experience and a deadly jump shot (and good free throw shooting).  But the younger Jordan was arguably as athletic as Carter as a Raptor.  Also Jordan had amazing basketball instincts--better than Carter IMO.

I like your reflexions on practice accounts and completely agree.  It isn't until you have real money on the line that the fear and greed set in.

I wonder however that in investing as in basketball, talent is more important.  You see, I wanted to be a professional basketball player as a 12 year old, and pursued that goal for the next four years.  But unfortunately, I was too short, to stocky, and certainly not athletic enough.  The shorter you are in basketball the less likely you will succeed.  My many years of practice, camps, and playing competively did not even lead to a place on the starting squad of my high school.  I can dunk however (in my dreams playing against Jordan)!

Though never cut out for professional sports, I've learned that I can invest successfully in this last 4-5 years.  It is one thing to have a successful strategy.  But it is quite another thing to overcome fear and greed at the right moments in order to implement that strategy most intelligently and effectively .  That is where, in my opinion, the talent or the true character of investor comes to the fore, and why practice may not help the person who is not cut out to be an investor.

Sivaram Velauthapillai
January 3, 2010 at 8:50 PM

I think Vince Carter still had way more athleticism, even if we look at the younger Jordan. I think Vince is also much stronger and can handle the power forwards a lot better than Jordan (but Jordan had far better passing skills so he didn't have to take on the PFs directly.) I think the big difference is that, as you point out, Jordan ahd the intensity and drive. Vince Carter either never had it or his injuries basically sucked it out of him.

It's fascinating to hear that you were seriously trying to make it in basketball. In all activities, there are always some limitations and your height clearly made it tough. You still had a shot--there are some great short players--but it is 50x harder!

In sports, physical traits (mostly due to genetics, food, and lifestyle) plays a huge role so it's tough to make it if one didn't already have it. I suspect the same thing is true for investing, except the required traits are different. Based on what you are saying it seems that you may have the right skills for investing. Congratulations on your good performance and keep it up. I haven't been too successful in investing so I'm still trying to figure it out.

When it comes to investing, my view is that half of it involves knowledge about assets, pricing them, thinking about business models, and so on; while half is your psychological reaction, particularly when you lose a lot or gain a lot. As you allude to, most investors have problems with the latter element. There are people on Wall Street and Bay Street who are far more talented in financial statement analysis, have more inside knowledge/industry contacts, can buy expensive research reports, etc, but can't pass the investment psychology test.

P. W. Dunn
January 3, 2010 at 10:04 PM

Honestly, at 5'8", and 12 inch vertical jump, I never had a chance at the NBA.  I can still hit a three-pointer, but unfortunately, in my day it was only worth 2 points. 

Your point about the analysts who have a great deal of information available is essentially correct. I'm reading slowly The Intelligent Investor, and it appears that the whole stock market is subject to psychological insanity, either too much greed or too much fear, and not a lot in between.


Cheers.

Sivaram Velauthapillai
January 3, 2010 at 11:19 PM

PW DUNN: "<span>Honestly, at 5'8", and 12 inch vertical jump, I never had a chance at the NBA.  I can still hit a three-pointer, but unfortunately, in my day it was only worth 2 points. "</span>
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<span></span> 
<span>This was when? The 70's? When did they bring in the 3 point line? At that height you probably needed to be faster than lightening and pass with your eyes closed to have any chance ;)  Shorter players in your generation probably had a chance but things are so much tougher now. Right now the defense is so tough that the game is getting skewed towards power at the expense of agility.</span>
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<span></span> 
<span></span> PW DUNN: "I'm reading slowly The Intelligent Investor, and it appears that the whole stock market is subject to psychological insanity, either too much greed or too much fear, and not a lot in between."


Yep... but it's the essence of humanity and it'll be with us for a long time. I personally attribute it to the crowd mentality, which is probably intrinsic to humans and maybe most mammals. Humans may have evolved from monkeys but I can't tell the difference between us and sheep ;)  I mean, I don't know how closely you were following the markets but during the chaos in late 2008, short-term US government bills were trading at negative yields for a short period! The smartest and best on Wall Street were willing to pay you to lend money to you! :-P  Too bad I never took advantage of any of the chaos in 08 and early 09...

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