195. Thumb rules - Beware of unexamined Common Sense!
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“Nonsense is so good only because common sense is so limited.” - George Santayana
The first several months of the COVID-19 Pandemic, i.e., from about March 2020 through the rest of the year or so, were a time of huge uncertainty. Governments and scientific community across the world were trying to get to grips with the scale and severity of the impact from the pandemic. One of the first few best practices that was almost universally prescribed was to wash hands every so often – once every ten to fifteen minutes. This prescription was drum-beat’d out of proportion by media of all kind. Only after a few weeks into the lockdowns, did I come to know of an unintended effect of this best practice. On a phone call with my mom, I came to realize that she was washing her hands religiously at the prescribed frequency. This would, perhaps, have been OK if she were a doctor or a care giver for COVID patients. But my mother was locked down in her house, just like of the most of humanity was at the time. She had no contact with the rest of the world and yet, she was washing her hands once every fifteen minutes. There was really no need for her to do this. This may sound like a harmless side effect but try washing your hands with soap every fifteen minutes for days on end and you will realize how painful it can get.
Unexamined best practices can easily be misleading and useless in the best case and can be downright harmful in the worst case.
For the purposes of this article, I’m lumping ‘best practices’, ‘thumb rules’ and ‘common sense’ together. Technically there may be some differences among these but in their application, they intend the same results.
“Best practices usually aren't.” - Christopher Locke
Here are a few other examples of common sense with ambivalent outcomes:
Great academic education leads to great careers. Many kids are forced to excessively (or even exclusively) focus on academics at the expense of other critical aspects of overall development such as sports, unstructured play, relationship with family and friends etc.
In the last few years, ten thousand steps a day has become a popular benchmark for daily dose of “optimal” exercise. I know of people for whom this daily target has become an end in itself. Sometimes, I wonder if the step-counter-wrist-watch manufacturing companies (or its ecosystem) spread the notion of the “10,000 steps”. The point is not everyone can do 10,000 steps a day. I think the idea is to move as much as possible and do as much walking as one’s personal circumstances allow, within reason.
Many large organizations have “Innovation/creativity” departments that are responsible for innovation. But I don’t think innovation can be engineered or willed this way – innovation emerges sporadically when right circumstances come together serendipitously.
Asset allocation is an important step in one’s wealth creation journey. One common allocation that is often spoken about is 60-40 (60% equity, 40% fixed income) but formulaic configurations such as (100-age) percentage allocation for equity, are also often touted as best practices.
Stocks with high price to earnings ratios (P/E) are considered overpriced and stocks with lower PE are considered underpriced. Stock markets are rife with stocks, among the wealth creating ones, that have almost always traded at high P/Es.
Those who did MBA from reputed schools (Ivy League, IIMs etc) are generally considered to be good at faculties such as business strategy or equity valuation. They are also assumed to be good at starting up businesses. In reality, most successful start-ups and most wealth creators in stock markets do not come from such educational backgrounds.
Best practices reduce energy and time expenditure and limit errors while making decisions – this perhaps is the main premise behind their value. But common sense could be hazardous too.
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“A good rule of thumb is to assume that everything matters.” - Richard Thaler
I found the “first principles” approach to applying thumb rules and best practices to be useful. Actually, a little more expansively speaking, I think that the value of “first principles approach” is not just limited to common sense. This approach is rather simple – it is an endeavour to learn the nuts and bolts of any rule or theory – trying to understand what aspects really drive value creation, what are the limits or boundary conditions and what are the core assumptions.
To give an example, I will resort to my favourite lever of wealth creation – “asset allocation”. Well, I believe that there is no one “ideal” benchmark for asset allocation – the “right” one is the one that maximizes the chances of one achieving one’s financial goals. 90%+ equity allocation may be suitable for some and 90%+ fixed income allocation may be suitable for some others. In fact, asset allocation percentages are incidental outcomes of personal financial plans rather than inputs.
“The first rule on breaking a rule is to know everything about the rule.” - Nuno Roque
With the first principles approach, over a period of time, my use of thumb rules has come down significantly. Most of my decisions now are made ground up from first principles. For example, given that I learnt that that over a long term, the performance of a stock will track the performance of the underlying business performance (specifically real earnings), most of the focus is on understanding the prospects of the underlying business. Stock price is only evaluated to make sure that it is not overpriced at the time of taking a position in that business.
When I do use thumb rules, I make sure that I adopt a stance of circumspection.
Bottomline
“Common sense is the collection of prejudices acquired by age eighteen.” - Albert Einstein
Generally, best practices or thumb rules evolve within a context, with specific settings, specific history and specific set of assumptions. Best practices or thumb rules shorn of their context may not always be relevant. When common sense is not accompanied by their “contextual” nuances, they may be misapplied and that may actually destroy value. So, the point is that common sense can be very valuable provided it is understood wholistically and applied judiciously. Easier said than done, though.
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