Occam’s Razor: A Primer on the Simplicity of Investment Decision Making

“We may assume the superiority ceteris paribus [other things being equal] of the demonstration which derives from fewer postulates or hypotheses.” – Aristotle

The theory that today we call Occam’s Razor, named after William of Ockham, a 14th century Franciscan Friar and theologian – who supposedly wrote, “Entia non sunt multiplicanda praeter necessitatem,” or translated, “More things should not be used than are necessary” – is occasionally called lex parsimoniae or “the law of briefness.” There is some debate as to whether this principle can be credited to William of Ockham, since there is no record of his writing these words and others before him such as Ptolemy – credited with saying, “We consider it a good principle to explain the phenomena by the simplest hypothesis possible” – have essentially stated similar philosophies, but that is neither here nor there.

In science, this principle is used as a heuristic to guide scientists. So how does this principle apply to investing in general and value investing in particular? Simplicity in making decisions is the key to Occam’s Razor and so I believe it to be in making certain decisions when investing. That’s not to say that investing is necessarily easy, but I believe we often get bogged down in minute details that oftentimes cause a major decision to sway one way or another; we easily get confused with such high volumes of information. With the talking heads and others speaking of such concepts as the Efficient Market Hypothesis (EMH), Kontradieff Waves, beta, gamma and a number of other “Greeks” as they call them, it’s easy to see why making investment decisions can seem so confusing and convoluted.

The inherent problem with much of the research, theories and formulaic strategies I read from other sources is that they focus more on the noise – the irrelevant and oftentimes assumptive conclusions – rather than simply referring to the evidence that is right in front of us. This is in part due to psychological tendencies in which we believe that when something seems simple, there must be another more difficult explanation, ignoring the fact that the original explanation behind a thesis was sufficient enough to come to a conclusion. This again can be summed up by the Indian Hindu philosopher Madhva in verse 400 of his Vishnu-Tattva-Nirnaya, in which he stated: “To make two suppositions when one is enough is to err by way of excessive supposition.”

Over the years of my working experience – from engineering and construction, to investment banking and investing – I’ve learned that two things have prevented me from having success in specific investments in the past: far too complicated theses and emotional ties to a specific investment. What do I mean by a complicated thesis? In essence, when instead of simplifying my investment process and not focusing on the core tenets of what I believe to be a successful investment, things tend to go awry. Again, this has to do with viewing companies in a more complicated manner and/or becoming emotionally invested in those companies, which I have found tends to cloud my judgment.

This leads us full-circle back to the theme of this missive: Occam’s Razor, which in its stripped down form is another way of saying simplicity is best. When reviewing the information of a potential investment, whether that be a great company selling at a discount or a possible short-candidate that I believe to be misleading investors, I don’t believe in making things more complicated than they should be. In fact, there is plenty of evidence to back up the notion that investing successfully is in part due to sound and simple decision making than not, but the point is, if we find ourselves making too many assumptions rather than finding clear answers when researching a potential investment, we place a great deal of faith in those assumptions and therefore a greater amount of risk in loss of capital. Again, that’s not to say that investing is easy in the sense that the “easy” in this case leads to great future returns; to the contrary, it can be extremely difficult if we don’t exercise the patience and emotional discipline necessary to achieve investing success.

Regards,

The Mitochondrial CFA