Defending Your Convictions
As you gain more self-confidence you realize the more defending you do the more you anchor yourself to yesterday’s conviction.
In 1979, inflation was running hot at 13% and President Jimmy Carter appointed Paul Volcker as chairman of the Federal Reserve. Volcker immediately increased interest rates from 11.2% to 20% over the next 12-months. The S&P 500 dropped 25%.
Throughout the 1970s, developing nations such as Mexico, Brazil, and Argentina borrowed heavily to fund industrialization. These loans were denominated in U.S. dollars and carried floating interest rates. These countries were now at risk of default due to the higher debt service.
By the fall of 1981, a 32-year-old Ray Dalio became convinced that the world economy was headed for a "Great Depression" style collapse.
He didn't just hold this view privately. He shouted it from the rooftops. He appeared on television and wrote articles to spread the word. On June 29, 1982, he even testified before the Senate, confidently asserting that a massive debt crisis would trigger a deflationary spiral and a stock market crash.
He was so certain of his analysis that he put his own money and clients' money behind a massive bet on a market downturn.
While the debt crisis was real, Dalio had completely miscalculated how Volcker and the stock market would respond. Volcker pivoted in July 1982 and cut the fed funds rate to 11%, and then again in August to 9.5%.
It didn't matter that Mexico announced they couldn't service their $80 billion in debt. Liquidity had loosened. The stock market ripped higher and went on one of the greatest bull runs in history. By the end of 1982 the S&P 500 closed at 140, up 40% from the August low.
The financial fallout was devastating. Dalio lost almost all his clients’ money and his own wealth. He was forced to let go of every employee at Bridgewater until it was just him, working out of his home. He had to borrow money from his father just to pay his family's bills.
The 1982 blunder was a pivot point. It taught Dalio that no matter how much evidence he thought he had, he could still be painfully wrong. This led to the development of his famous Principles, specifically:
Stress-Testing: He began seeking out the smartest people he could find who disagreed with him to understand their reasoning.
Diversification: He realized he needed to balance his bets so that no single "certainty" could ever wipe him out again.
Systematization: He moved away from purely emotional or intuitive betting toward building algorithms that could account for various economic scenarios.
Dalio often says that while the experience was humiliating, it was the best thing that ever happened to him. It shifted his mindset from thinking "I'm right" to one of radical open mindedness. This shift in perspective allowed Bridgewater to eventually become the largest hedge fund in the world and Dalio to be one of the richest men in the world.
If you’ve been a stock picker for more than five years, you’ve likely had a Ray Dalio moment. You found an investment opportunity. You built extreme conviction. You told the world about it and maybe got family and friends to buy in. Then you were dead wrong.
We often have such extreme conviction in the beginning of every investment when our expectations are at their peak. We haven’t given the management team, business, external forces enough time to disappoint us. The more reps we accumulate the more we know this and yet we defend our stock positions and convictions like they are our children. We defend them like our conviction will never waiver, even though it almost always does.
When I was getting started and building my reputation I felt like a street fighter. I was defending my ideas on all fronts. From longs, from shorts, from even myself. It was a full-time job to try to prove how smart I thought I was.
As you mature as a stock picker and accumulate more reps, you start to understand your own base rates (hit rate, payoff ratio, etc). You begin to respect how quickly conviction changes, especially in microcap. You start to understand that businesses don’t operate in a vacuum. Businesses are dynamic and conviction must also be dynamic.
I may love a company today, but there is only a 10% chance I will love it in 24-months. This is further proof you shouldn’t talk openly about your positions unless you are strong enough to change your mind in front of the crowd. The more defending you do, the more you anchor yourself to yesterday’s conviction.
It's funny when you think about it. We all sort of like the same companies. We just differ on valuation and time horizon.
We would all own Google at 1x earnings. Few would own Google at 100x earnings.
We would all own an opportunity if the upside was easily captured within 3-months (the next quarter). If the catalyst, acceleration, inflection gets pushed out to 12-months, most microcap investors go away.
Most of our differences are on valuation and time horizon, not even the company itself.
As you grow and mature and develop self-confidence in your abilities you don't feel the urge to defend your convictions as much.
Why? We all invest differently and there is a 99% chance you too will change your mind in the future.
Ray Dalio learned to develop radical open-mindedness, and this is a mindset all microcap investors must develop. Any practice, action, or habit that slows you down from seeing reality must be eliminated. I have high conviction in all my positions today, but I'm open to changing my mind tomorrow.
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