Successful investing can only result from good thinking or good luck. Because we only control the former, I am always on the lookout for books about the process of thinking. One such book is A Few Lessons from Sherlock Holmes. Holmes’s approach is rules-based, disciplined, and often unconventional: three hallmarks of many successful investors and superior investing strategies. Holmes would have been a great investor, so below I present the best lessons he has to offer modern investors. At the end of this article, I’ve included further reading for each point mentioned.
Holmes believed in casting a wide intellectual net: he believed that a broad education is key:
Considering many ideas over a wide range of disciplines give us perspective and help us consider the big picture or many aspects of an issue Breadth of view…is one of the essentials of our profession. The interplay of ideas and the oblique uses of knowledge are often of extraordinary interest. (Holmes; The Valley of Fear)… One’s ideas must be as broad as Nature if they are to interpret Nature. (Holmes; A Study in Scarlet)
There is a lot of Sherlock Holmes in Charlie Munger, who also advocates a wide ranging understanding of the major disciplines. Like Munger, Holmes was also a fan of “inverted” thinking: working backwards to tackle hard problems:
In solving a problem of this sort, the grand thing is to be able to reason backward. That is a very useful accomplishment, and a very easy one, but people do not practice it much. In the everyday affairs of life it is more useful to reason forward, and so the other comes to be neglected. (Holmes; A Study in Scarlet)
Sherlock is also a believer in the power of probabilities:
While the individual man is an insoluble puzzle, in the aggregate he becomes a mathematical certainty. You can, for example, never foretell what any one man will do, but you can say with precision what an average number will be up to. Individuals vary, but percentages remain constant. So says the statistician. (Holmes; The Sign of the Four)
Replace the word “person” with the word “stock” in the above paragraph and you’d be well on your way to a smart strategy. Probabilistic reasoning is the best way to think about markets, but it is very hard to do in practice because we tend to get caught up in individual companies. To build an investing process dependent on probabilities requires steadfast discipline, because probabilities only work if you stick with them (value investing is one great example). There is a reason casinos do well: the probabilities are on their side and the rules never change. Sherlock realized the power of such a consistent approach:
Don’t forget common sense My simple art…is but systematized common sense. (Holmes; The Blanched Soldier)
The acquirement of method is more or less possible for us all…It is only by adhering rigidly to a definite routine with patient after patient and day after day that a proper reflex can be obtained. (Thomas McCrae; The Method of Zadig)
Finally, Holmes realized the power of learning from history, because most current events are just old patterns wearing new clothes:
Sorrow is often wisdom’s companion but it is better to learn from others sorrow to prevent our own
Mr. Mac, the most practical thing that you ever did in your life would be to shut yourself up for three months and read twelve hours a day at the annals of crime. Everything comes in circles…The old wheel turns, and the same spoke comes up. It’s all been done before, and will be again. (Holmes; The Valley of Fear)
It is easy to be wise after the event. (Holmes; Thor Bridge)
Here, then, is the Sherlock Holmes outline for a great investor, along with a follow up item for each point (in parentheses)
- Understand the basics across a number of different disciplines (read about Charlie Munger’s latticework of mental models).
- Think backwards from effect to cause rather than trying to predict the future (read more about inverted thinking for investors at Old School Value)
- Put yourself on the right side of market probabilities (read about how valuation can help you sort of market probabilities)
- Make your process rules based (check out What Works on Wall Street for a survey of systematic, rules-based strategies)
- Learn as much as you can from history (read Devil Takes the Hindmost)
- Stick with Sherlock, and your investing future will be bright.
P.S. This coming month’s book list will be devoted to books in this vein, so sign up over here if you have not already.