Principle 1

The Bell Curve and the Gap Instinct - Beauty and the Beast.

The gap instinct is our tendency to - often incorrectly- separate everything into two groups. Groups such as rich & poor, developing & developed, left wing & right wing, good & bad, and "short" & "long", or "sell" & "buy". This stems from a human need to differentiate between things. In investing, such categories can be dangerous, and will result in traumatic failure. This is because such categories encourage you to act. If a company can only be a "buy" or "sell", then you will inevitably hold a strong opinion, and concurrently a position; being either a buyer, or a seller - or even a short seller. This will lead you to put companies in one group or the other, when in reality, there are both, factors which make each company a "buy", and factors which make it a "sell". Hence, if for example you are clubbing a company as a "buy", you will likely be ignoring the reasons it is a "sell", and focusing on the reasons it is a "buy", or vice versa. Of course, any action taken without facts, is unlikely to be successful. 

This is where the bell-curve comes to the rescue. If we consider that everything lies on a range, and identify where the majority lie, we can be better judges of everything. We would find, that most people are on middling incomes, that most countries are quite developed but still developing in tandem, that most people lie about the centre of the political spectrum, that mot things are  simply, "okay", that most companies are neither "longs" nor "shorts", and that most companies are neither "buys", nor "sells"! In investing, such a thought process would lead you to act less frequently. Indeed,  it encourages you to be more cautious, and will probably result in you having a much more concentrated portfolio. 

Indeed, the caution and selectivity induced by the bell curve into portfolio management is crucial. Howard Marks says, "If we avoid the losers, the winners will take care of themselves". Similarly, Warren Buffett recommends a 20-slot rule, where you make only 20 investments in your entire lifetime, and punch a hole in a card each time. Both of there principles recommend a more selective, cautious approach to investing. In brief, the bell curve is great, because it - like the 20 slot rule - encourages us to be more selective - and cautious - and recognise that very, very few companies are actually "good" companies to invest in - most are just "okay"!!