Money Sundays: Second Order Thinking

Readers, I want to share a mental tool with you, a tool I used incessantly in my days as a professional investor--and still use today as a individual investor: Always ask the second order question.

What are second order questions? They're meta-questions, or questions about first-order questions. One way that helps me think in second order terms is to make a habit of asking myself "and then what?"

Let's look at an example. Consider the following (rather defeatist) first-order question: "Why bother with investing? The stock market's rigged anyway."

In its first-order form, this is a ready-made rationalization for not even bothering to learn about investing at all. Forget it, what's the point? Didn't you hear me say it's rigged? You could stop right there and be done with the whole domain.

Or, you could ask a second-order question: "If the stock market's really rigged, then what?"

This is the kind of question that opens mental doors, and often there's a gigantic opportunity behind those doors. For example, you could conclude "If the stock market's rigged, maybe I should invest in the companies that are supposedly 'rigging' it… I bet I could make some very good returns piggybacking on those guys."

Suddenly, a yuge cognitive door opens, which might help you discover the stocks of well-regarded investment managers like T. Rowe Price [TROW] or Legg Mason [LM]. Or alternatively, you might discover the stocks of well-regarded private equity firms like Carlyle Group [CG], KKR [KKR] or Blackstone [BX]. "Hmmm which of these companies pays consistent and attractive dividends with good dividend growth potential?"

Now you're off and running with some potentially very intriguing investment ideas.

There's more. As we saw in a recent post, you can now quite easily find investor letters and 13F filings that offer incredibly useful insights and investment ideas from some of the best hedge funds and investment funds around. You know, all those fatcats out there supposedly rigging the stock market.

Heck, why pay some hedge fund an insane "two and twenty" fee structure (2% of assets and 20% of gains) when you can borrow their ideas for free?

Never stop at the first-order question. Ask the second order question, and always try to engage in second order thinking. It's a lens for looking at reality. Using it helps you think more deeply, and it leads you to opportunity for you and your family.

For further reading:
For much more on the concept of second order thinking, see Howard Mark's book The Most Important Thing.

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