She Strengthens

The Secret to Beating the Market: Understanding Second-Level Thinking

A World of Smart Investors

The market is a battlefield where smart people, including mutual fund managers, hedge fund managers, strategists, and economists, fight to outsmart each other. They’re all trying to make a bigger buck than the average person through their trades. But here’s the brutal truth: for every winner, there’s a loser. To succeed, you need to buy an asset cheaply, at someone else’s expense.

The Reality of Professional Investing

The market is filled with people who estimate values, trade stocks and bonds, and make a living by investing. For every buyer, there’s a seller. This dynamic makes it increasingly difficult for individual investors to make a profit. As soon as people realize there’s a resale opportunity, everyone jumps in, reducing the profit margin.

The Wisdom of Howard Marks and Charlie Munger

Howard Marks, a genius in the bond market, has repeatedly emphasized the importance of Second-Level Thinking. Charlie Munger, another great investor, once said, “It’s not supposed to be easy. Anyone who finds it easy is stupid.” With so many smart people competing for profits, the opportunities for excess returns are minimized.

The Limitations of First-Level Thinking

Achieving average, long-term profit results is easy enough through an index fund or an ETF. However, for those who aspire for more immediate, larger margins of profit, you need to understand Second-Level Thinking. First-Level Thinking is simplistic and superficial, considering only the first effect, the first layer of the market, and the first course of action. It’s single-plane thinking that ignores the part that other investors play in how prices change.

The Power of Second-Level Thinking

Second-Level Thinking says, “It’s a good company, but everyone thinks it’s a good company, and its future may not be as rosy as its past. So, the stock’s overrated and overpriced; let’s sell.” It’s a different level of thought process that considers the obvious factors and then digs deeper. If something is obvious to you and all of your friends, the price of the company’s shares already reflect this obvious quality. Picking your near-term entry points and exit points for investing by following the herd is a recipe for investing failure.

The Key to Long-Term Success

To succeed in the markets, you need to think on the Second Level. Ask yourself, “Am I about to show my First-Level thinking chops, or can I ask the Second-Level questions that will truly contribute to the discussion at hand?” By doing so, you’ll increase your chances of beating the market and achieving long-term success.