Why Self-Esteem is Necessary to Future-Proof Your Child, and How to Give It to Them

The formal study of the psychology of self-esteem is a modern development, while the concept itself is timeless, immemorial and universal to the nature of the human mind. That we only recently discovered it as an intellectual category and began to examine its principles and the practical applications thereof in concrete detail does not mean that self-esteem was not an operant condition of the human psyche throughout history.

The spirit of the ancient world and the pre-modern past is often thought to be one of tradition and imposed order. Every person was born into a certain station in life which they would inhabit, without change or any particular effort, until their death. Another way to consider this set of circumstances is that the past was a place of entitlement. Entitlement often carries a pejorative connotation indicating undue privilege, but in its broadest sense it applies to any situation in which people deem what they have and what they are due to be a function of “who they are” rather than “what they have done” and it applies to high and low alike.

The emergence of markets, of dynamic technologies and of new thinking about meritocratic social orders heralded the arrival of the age of personal responsibility trodding over the threshold of the age of entitlement. In this new world, the modern world, people had new opportunities to change their station and position in life through strategic ideas and the will to carry it out. Life outcomes began to shift from what role or relationship they were born into, to being due more and more to individual thinking and decisions people made over the course of their lives.

This age of responsibility, unlike the age of entitlement that preceded it, demands active engagement with the psychology of self-esteem to maximize the opportunities presented. Rather than finding oneself resentful, frustrated and confused by an ever-changing society, business and technological landscape, the individual who has mastered the psychology of self-esteem is enabled to continue to change their own ideas and with them, their actions, in relation to this kaleidoscopic shifting of external reality and continually stand to benefit from whatever arrangement it takes. In contrast, the individual living with entitlement feels threatened by change, discouraged by having to think and come up with new plans and ultimately concludes that personal transformation is hopeless and if they can not benefit from progress, they ought to stand in its way and at least enjoy the satisfaction of gumming it up for their historical antagonists and enemies.

The parenting of the past, founded on authority and parental license and the diminution of the individual identity of the child to prepare him or her for their “entitled” adult future, is a severe liability in the modern world and one which few have come to terms with or even understand as a problem. An ever-changing future demands a growth, rather than a fixed, mindset, and a growth mindset stems from confidence in the self’s ability to remain flexible and adapt to new conditions. In other words, a growth mindset is directly tied to the psychology of self-esteem.

Self-esteem being at root a relationship that one has with oneself — feelings of personal worthiness and the capability to seize the good in life — it is incumbent upon parents who wish to “future-proof” their children in a world of hyperactive change to start in infancy with a parenting approach based upon respect. The respect shown for the infant becomes a model for the later child and future adult in how they should relate to themselves.

In other words, parents who wish to benefit from the modern knowledge of the psychology of self-esteem so as to arm their children with a growth mindset in a continuously developing world that demands the greatest creativity and flexibility of thinking to seize the numerous advantages presented on an almost daily basis, should start by grounding their parenting approach in respect for the individual child before them.

Review – Feeling Good

Feeling Good: The New Mood Therapy

by David Burns, published 1980, 2008

This post is less a review of the book and more an exploration of its major philosophical principles and techniques.

Major Principles

All your moods are created by your cognitions, or thoughts, including:

  • perceptions
  • mental attitudes
  • beliefs
  • interpretations

When you are feeling depressed, your thoughts are dominated by pervasive negativity which infect all of your experiences, including:

  • reflections on the past
  • experience of the present
  • projections/expectations of the future

Negative thoughts at the heart of emotional turmoil almost always contain gross distortions, therefore:

  1. gains in objectivity of thoughts translate to elevated mood
  2. the most crucial predictor of recovery is a persistent willingness to exert some effort to help yourself
  3. it is a part of the human experience to be periodically upset, “getting better” means systematically employing CBT methods to master thoughts and moods over the course of a lifetime

Diagnosing Your Moods

You can use the Burns Depression Checklist (the author’s proprietary list of indicators of depressive thinking) weekly to chart the progress of your depression’s severity. This is important because it introduces objective data into your self-experience. By seeing the change in data over time as a result of specific action, you can break the allure common to all depressive episodes that the present experience is likely to continue on indefinitely, or only get worse.

Understanding Your Moods

Depression is not an emotional disorder, it is a disorder of thoughts.

Practice noticing the negative thought you had just prior to your negative feeling. This will help you generate awareness about the specific “triggers” that instigate a depressive mood. You will begin to notice that right before you feel downcast, you have made a critical or despairing assumption about yourself or other people.

One argument depressed people make is that their depressive mood is an accurate reflection of a depressing reality. However, emotions do not happen automatically based upon experiences, but rather experiences are processed in the mind and filtered through pre-existing thoughts before being translated into an emotional state. Therefore, if your understanding of reality is normal, your resulting mood will be normal; if your understanding of reality is distorted, your mood will be distorted as well.

Thinking you are the one “hopeless”, truly flawed person in the world is a sign of distorted thinking. This is a belief based upon fallacious logical thinking rather than an objective, existent fact about reality knowable to all.

In its essence, depression is a highly credible form of faulty faith in a reality that doesn’t exist. Truly, the cure for long-lasting depression is a “scientific mind” determined to observe and examine reality using sound logical principles.

The 10 Major Cognitive Distortions

Depressive episodes are triggered by one of ten common cognitive distortions, or fundamental logical fallacies embedded in the assumptions and thinking of the depressed individual:

  1. All-or-Nothing Thinking, a form of perfectionism
  2. Overgeneralization, believing a single instance is an inevitable pattern
  3. Mental Filter, focusing on the negatives, ignoring the positives
  4. Disqualifying the Positive, turning positive experiences into negative ones by rationalizing why it was luck, a mistake or otherwise unrepeatable or undeserved
  5. Jumping to Conclusions,
    1. mind reading, convincing yourself others harbor negative thoughts or evaluations without checking it out
    2. fortune-telling, imagining something bad will happen without evidence or probability
  6. Magnification and Minimization, creating a sense of inferiority by catastrophic thinking about flaws and mistakes, while downplaying strengths or achievements
  7. Emotional Reasoning, confusing a negative feeling with a factual truth about reality
  8. Should Statements, frustrating yourself by comparing yourself and others to a perceived ideal rather than accepting reality as it is
  9. Labeling and Mislabeling, confusing your identity with a single action or perpetual state of being
  10. Personalization, taking responsibility for things that have nothing to do with you, or are outside your control

Sometimes people experiencing depression worry that if they do not experience the grief and upset feelings of depression, they will not be living authentically. Getting in touch with and expressing valid emotions based upon valid thinking, is a form of emotional maturity; expressing invalid emotions based on invalid thinking is a personal and sometimes social problem that is not at all desirable. Emotional growth and development involves ridding yourself of invalid thinking and the harmful, deluded and invalid emotions that come with it.

Defeating Do-Nothingism

In a depressive state of mind, it can be difficult to summon the determination, motivation and interest in moving one’s goals and life plans forward. Using the major principle mentioned earlier, it is important to consider what kind of self-critical triggering thoughts precede this unwillingness to act. When you are suffering “do-nothingism”, consider the following as a new mental habit:

When I think about an undone task, what thoughts immediately come to mind?

You are likely to find that these thoughts are filled with the logic of futility, hopelessness and general nihilism and discouragement.

Common Mindsets that Yield Action to Inaction

Here are some common cognitive distortions that precede do-nothingism:

  1. Hopelessness, the present pain is overwhelming and obstructs your ability to imagine an improved future
  2. Helplessness, something other than your own actions stands between you and achievement
  3. Overwhelming Yourself, you must do the whole tasks all at once, making it impossible
  4. Jumping to Conclusions, assuming without testing to find out
  5. Self-labeling, convincing yourself you’re fundamentally incapable by labeling yourself as such
  6. Undervaluing the Rewards, the payoff is so small, why bother?
  7. Perfectionism, preferring no progress to some progress
  8. Fear of Failure, it isn’t worth an attempt if the potential to succeed lies in doubt
  9. Fear of Success, you won’t be able to continue after your initial “luck”, so you don’t bother
  10. Fear of Disapproval or Criticism, you will be judged harshly by others for your attempt
  11. Coercion and Resentment, you are being forced to do something rather than choosing to do it for yourself
  12. Low Frustration Tolerance, or Entitlement Syndrome, it should be easy to succeed, if it’s not easy, you must not be made out for success
  13. Guilt and Self-Blame, punishing yourself over past perceived mistakes

You may notice that many of these cognitive distortions are simply “inaction-specific” versions of the earlier list from above.

Dealing With Anger

Anger is a common aspect of many depressive episodes. As depressed people tend not to carry out the values of their lives into action, they often experience frustration, resentment and anger about the seeming futility and malaise of their life, particularly when they are in touch with or aware of their latent talents and abilities. Anger is often directed outward at others as an expression of the pain within.

When you label someone, you tend to apply a mental filter that results in disqualifying the positive as you emphasize their poor traits and ignore their good ones. Labeling gives way to blame, blame leads to vengeance. Ironically, you can not enhance your self-esteem by attacking someone else’s, so this act of labeling and attacking the character of others in anger proves doubly harmful.

Mind-reading also leads to anger as you will tend to attribute false ideas and motivations to the other person’s behavior.

Magnification of the original negative event will cause greater than necessary pain and cause the pain to linger longer than it must.

Should/should not statements generate entitled beliefs and entitled thinking leads to resentment and frustration with other people as well as the self.

The perception of unfairness or injustice is the ultimate cause of anger. It is the emotion that corresponds 1:1 to your belief that you are being treated unfairly. Significantly, there is no universal standard for fairness or justice, only different ethical systems based upon tradition, circumstances and logical rationalization of self-interest and specific harmony.

Arguments over who is “right” are fruitless and unresolvable.

Some anger is healthy in motivating change. But to determine if your anger is motivational or de-motivational and depressive, consider these two criteria for anger:

  • is it directed at someone who knowingly, intentionally and unnecessarily acted in a hurtful manner?
  • is my anger useful? Does it help me achieve a desired goal or simply defeat me?

Techniques for managing anger:

  • use the double-column technique to explore advantages and disadvantages of feeling angry and engaging in retaliation
  • one you’re ready to calm down, use two column “hot thoughts” versus “cool thoughts” to explore angry versus rational thinking
  • rewrite your “should” rules to break free of entitled thinking
  • change your expectations of others, allow yourself the opportunity to see their behavior as predictable and not surprising
  • try empathy, see the world from your oppressor’s eyes and understand how what they did made sense and wasn’t personal

Examing Depressive Thinking

Some people are so depressed, all they can do is carry their whining and complaining with them everywhere they go. How do you deal with a whiner? Try the Anti-Whiner Technique– when someone complains, agree and compliment, don’t try to help. People who whine never want help solving their problems, they are looking for validation and security from others that their pain is real. By offering solutions, you unwittingly end up sending the message to the whiner that they’re incapable of helping themselves, are being victimized by reality and thus should continue whining!

There is no such thing as a “realistic” depression, although there are realistic reasons for temporarily feeling sad. Consider these two ideas about “realistic” depression:

  • sadness follows real loss or failure, is temporary and never impacts self-esteem negatively; this is a “realistic” depression
  • depression follows flawed or distorted thinking, is recurring and stems from/causes a loss of self-esteem; this is an “unrealistic” depression

Preventing future depressions:

  1. understand why you got depressed (many people never graduate beyond this step because they spend their entire lives in some form of depression!)
  2. know how and why you got better; what techniques were effective?
  3. acquire self-confidence and self-esteem
  4. locate the deeper causes of your depression (many people suffer recurring depression because they never bother to understand what kind of life experiences have made them vulnerable to depression, so they can be on guard against repeating these experiences or the harm of taking the wrong lessons from them)

Downward Arrow Technique, used to mine automatic thoughts for “logical consequences” of silent assumptions, the residue of recurring depressive episodes; then “talk-back” is used the challenge these beliefs.

Taking Action Against Depression

What problems do you face? How are you solving them? This is where the action is, not “worth” or “true self”.

People can spend their whole lives trying to get beneath their depression to an authentic understanding of self when really the difference between a depressed person and a non-depressed person, ultimately, is a willingness to take action to solve one’s own problems.

Why treat yourself in ways it would be rude or uncomfortable to treat others? Encourage yourself to identify your problems and create strategies for resolving them. In taking action, you’ll find your own capability and begin to let the depression go.

Fighting perfectionism:

  • make a list of pros and cons
  • ask yourself if the standard could ever be realized
  • use response-prevention technique and ride the discomfort of not checking
  • become process-oriented, which is in your control, rather than goal-oriented, which is not
  • unwillingness to make mistakes leads to lack of risk-taking; write yourself a note on the value of making mistakes
  • take ownership of your mistakes and assert your right and necessity to make them to keep growing, to yourself and to others

Review – The Drama Of The Gifted Child

The Drama of the Gifted Child: The Search for the True Self

by Alice Miller, published 1979, 1997

Recently I was discussing economic and social philosophy with some friends and the question came up about why certain philosophical ideas aren’t more popular or well-known if they seem to be more logically correct than the alternatives. We entertained a number of reasons why this might be but the one that stuck out to me as particularly weighty is the idea that the truth is deep, long and heavily nuanced and doesn’t make for quick, emotional soundbites. I made the quip, “Why is the economy the way it is? Do you have 5 years to study what you’d need to know to understand it?” followed by, “Why does the political system look as it does today? Do you have an entire lifetime to devote to studying all of human history?”

The other weighty suggestion that was offered is that there are many philosophies that cater to telling people what they want to hear (ie, an easy to accept reality) and only one that emphasizes telling it like it is (ie, a hard truth about reality).

I see echoes of these two notions in the opening of Alice Miller’s “Gifted Child”:

The damage done to us during our childhood cannot be undone, since we cannot change anything in our past. We can, however, change ourselves. We can repair ourselves and gain our lost integrity by choosing to look more closely at the knowledge that is stored inside our bodies and bringing this knowledge closer to our awareness. This path, although certainly not easy, is the only route by which we can at last leave behind the cruel, invisible prison of our childhood. We become free by transforming ourselves from unaware victims of the past into responsible individuals in the present, who are aware of our past and are thus able to live with it.

Most people do exactly the opposite. Without realizing that the past is constantly determining their present actions, they avoid learning anything about their history. They continue to live in their repressed childhood situation, ignoring the fact that it no longer exists. They are continuing to fear and avoid dangers that, although once real, have not been real for a long time. They are driven by unconscious memories and by repressed feelings and needs that determine nearly everything they do or fail to do.

This book asks the reader to consider two troubling ideas. The first is that they are likely to be carrying some emotional baggage from their childhood that originates with the way they were cared for by parents and other important adults in their lives. The second is that they are likely to transmit this baggage to their own children (if they have any) and other important, intimate relationships if they don’t find a way to come to terms with it beforehand.

Like the consideration made about the popularity or penetration of certain economic and social philosophies, these ideas are troubling for most people to accept because it forces them to revise their current understanding of the relationships they have with important people in their lives, it forces them to take responsibility for the course of their lives and their choices and give up the perverse safety and security of seeing life through the eyes of the helpless victim and it forces them to concede that the present is not a unique or isolated moment pregnant with infinite possibilities, but rather one moment at the end of a string of moments stretching back into the earliest reaches of human history in which possibilities exist but are limited by certain choices and events which took place in the uncontrollable past.

There is of course great freedom in choosing to explore these troubling ideas but they come at the cost of a grave responsibility that few, based on my practical experience, seem willing to bear.

To find this freedom, one must seek out “the lost world of feelings.” Human infants are entirely dependent upon their adult caretakers for their survival, unlike most other animals who, while weak and undeveloped, are nonetheless able to move around, seek shelter, find food, etc., on their own almost immediately after birth. For a young human, being ostracized or unloved by ones parents is a death sentence. Therefore, the human psyche is wired at birth to prioritize adapting to the parents’ emotional needs over fully developing its own.

If certain emotional expressions or behaviors prove to be problematic for the relationship with the parents, the human child will work to repress and hide that part of themselves. They will disown it and their personality will become dichotomized into “me”, the feelings and behaviors and characteristics I acknowledge and accept because they have demonstrated value with my parents, and “not me”, the feelings and behaviors and characteristics I deny possessing or experiencing because they have been a source of conflict with my parents, on whom I depend for survival.

This is what Miller means when she talks about searching for the “true self.” The irony, however, is that

the child does not know what he is hiding.

That is, it is not as if the child knows what his true self is and isn’t and is lying to himself and others about who he really is. It is more like, he has shoddy vision and can’t see a focused image of himself in true detail, or else he has a map of himself leading to the buried treasure of his own reality but he doesn’t know how to read the map and therefore doesn’t know where his self is or even what he’ll find when he gets there. Every now and then this person might get a glimpse or a sense of their true self in a particularly emotionally charged moment but really all they’re experiencing is the anxiety indicating the existence of repressed and disowned selfhood, not a look at what is missing.

To heal, these emotions must be encountered and experienced. Further, painful emotions must be resolved by tracking down their genesis in early childhood experiences. Memories and relationships with respected and important adult caretakers must be studied and re-evaluated through the more objective eyes of an independent adult rather than the way they were first constructed by a subjective and immature child. This not only allows the adult of the now to be released from the terrors of the former child but it can enable the adult to have new modes of living and doing:

Rational, constructive action depends not only on the intactness of our intellectual faculties, but also on the extent to which we have access to our true emotions.

[…]

the inescapable conclusion is that for people to be able to organize their lives, they must have access to their emotions.

This is one of the many and for me, the most important, takeaways from this book. It is not enough to rationalize about a choice and a potential plan of action. To actually develop an impetus to act requires an emotional experience. Adults who repress certain parts of their emotional selves due to childhood traumas become incapable of acting in certain areas of their lives. They become procrastinators, perfectionists or otherwise evasive in the area of making a decision, acting on it and then sticking with it.

By finding and integrating one’s lost world of feelings, one has the opportunity to become active and empowered in new areas of one’s life that were otherwise mysterious, frustrating or dormant.

One question that comes up for some people as they consider all of this is, “But why did my parents ever treat me in such and such a way?” Using some of the memories and recollections of a famous cultural writer as an example, Miller says,

like so many gifted children [he] was so difficult for his parents to bear not despite but because of his inner riches. Often a child’s very gifts […] will confront his parents with conflicts that they have long sought to keep at bay by means of rules and regulations. These regulations must then be rescued at the cost of the child’s development.

The parents’ childhoods involved repression as well. For their own survival they learned to disown parts of their emotional experience or certain of their behaviors that caused trouble with their parents. They rationalized this turn of events and created rules for living that would help them avoid these perceived dangers. And then when they had children, these rules and procedures came into question by the existence of the innocent child. And so a new round of repression is started.

The only way the cycle can be broken is for the adult to make the painstaking effort to connect with his child self and understand what happened and how it has impacted him, and then he must choose to live his life differently with that new awareness of his past. This is hard for many to do because

What they do not see, because they cannot see them, are the absurdities enacted by their own mothers when they were still tiny children.

Another powerful idea contained in this book is an explanation of the appeal of irrational ideas to adults with traumatic childhood experiences. The trauma of childhood is itself irrational– there is no “reason” for any child to be abused or neglected by those who brought it into the world, and save those who are simply unlucky in having some external misfortune befall their family (ie, the child is made an orphan when the parents die unexpectedly), there is no excuse or justification the adults could offer a child as to why they are being treated as they are. For survival reasons, the child must make a place in their psyche for irrational ideas to exist because in doing so they “close the loop” on the irrationality and make it seem rational. “Some things just don’t make sense” is a way to make sense of things that don’t make sense.

When this space for irrationality exists, adults can become wedded to irrational ideas and beliefs, such as political ideologies, abusive social relationships or supernatural superstitions. On one hand, they lack the ability to rationally resist these ideas and beliefs because they are willing to accept that not everything has to make rational sense in their lives. On the other hand, they may positively identify with the claims of these ideologies because they appeal to their own experiences or sense of self as a victim who is oppressed by others, that is, they offer a way to feel like they’re getting even. On this point Miller is worth quoting at length:

Oppression and the forcing of submission do not begin in the office, factory or political party; they begin in the very first weeks of the infant’s life.

[…]

Political action can be fed by the unconscious rage of children who have been misused, imprisoned, exploited, cramped and drilled. This rage can be partially discharged in fighting “enemies”, without having to give up the idealization of one’s own parents. The old dependency will then simply be shifted to a new group or leader. If, however, disillusionment and the resultant mourning can be lived through, social and political disengagement do not usually follow, but our actions are freed from the compulsion to repeat. They can then have a clear goal, formed out of conscious decisions.

Once our own reality has been faced and experienced, the inner necessity to keep building up new illusions and denials in order to avoid the experience of that reality disappears. We then realize that all our lives we have feared and struggled to ward off something that really cannot happen any longer; it has already happened, at the very beginning of our lives while we were completely dependent.

The term “fighting yesterday’s battles” comes to mind when thinking about this irrational space.

While Miller’s analysis applies to any child and any adult experiencing emotional pain and depression (whether they’re aware of it or not!), the book is especially focused on the plight of “gifted” children because of the uniquely problematic experience they can have in this area due to their talents and abilities. Not only do “gifted” children tend to experience these emotional troubles more deeply,

many people suffering from severe symptoms are very intelligent

but they also tend to experience these troubles uniquely through feelings of grandiosity and contempt.

Grandiosity is the concept of identifying one’s personal value as a person with one’s special talents and abilities. One’s greatness isn’t just a part of one’s self, it IS the self. But this complicates the emotional life of the gifted child because it is inevitable that not every part of themselves is grand. There exists then another dichotomy, wherein all the parts that are grand (which may be very few and overall represent a quite limited part of the total person or experience of self) are “me”, and all the parts that are normal or weak (which is likely then the majority and the wider experience of self) are “not me”. And if my parents love and care for the grand gifts I have but dislike or don’t know how to deal with the unexceptional aspects of my self, then

we remain at bottom the one who is despised, for we have to despise everything in ourselves that is not wonderful, good, clever… we despise… in short, the child in ourselves and in others.

[…]

“Without these achievements, these gifts, I could never be loved. would never have been loved.”

An emotional experience that often goes hand in hand with grandiosity is contempt.

The function all expressions of contempt have in common is the defense against unwanted feelings. [ie, despising what is not grand about oneself]

[…]

Once we are able to feel and understand the repressed emotions of childhood, we will no longer need contempt as a defense against them.

[…]

Contempt as a rule will cease with the beginning of the mourning for the irreversible that cannot be changed… it is, after all, less painful to think that the others do not understand because they are too stupid.

Gifted people often experience contempt for others as an expression of insecurity about the repressed parts of themselves that are not part of their gifts. Unable to have empathy and kindness towards themselves in these areas, they become impatient and hostile towards those reminders of their own weakness that they see in others.

Sadly,

hating and offending an innocent person, using him as a scapegoat, can only strengthen the walls of our inner prison of confusion, isolation, fear and loneliness: it cannot free us.

And the most innocent person of all, the most unfair scapegoat a person can choose in this drama, is their child self. Whether these ideas are new or familiar, I encourage anyone reading this to consider the implications of the ideas contained in this book not as if they describe a set of generalized human experiences but rather as if they describe something specific and personal to the reader himself. If this book’s message can be taken to heart and internalized, it can be the jumping off point for great personal change that will ultimately resolve itself in what Miller refers to as a “healthy self-feeling”:

I understand a healthy self-feeling to mean the unquestioned certainty that the feelings and needs one experiences are a part of one’s self.

 

Review – How Children Learn

How Children Learn

by John Holt, published 1995

John Holt says the essence of his book can be boiled down to two words: “Trust children.” We hear echoes Magda Gerber’s RIE philosophy motto (“slow down”) and Maria Montessori’s “secret of childhood.” If we trust children, what are we trusting they will do and on what basis is the trust being given?

We trust that children will make not only good choices, but the right choices with regards to where they are in their personal development, that they will engage in behaviors and follow curiosities that maximize their ability to learn about themselves and the world around them and how it works. And the basis of this trust is that children are fundamentally competent to be themselves without any additional input, guidance or motivation from parents or other adults, who at best can merely replace the child’s ego with their own.

In reading Holt, I was constantly reminded of my friend’s book, A Theory Of Objectivist Parenting, which asks the reader to consider the philosophical dilemma of how an individual who is treated as incapable and irresponsible for most of their developmental life can suddenly be expected to be a functioning adult with the snap of two fingers. Where lies the magic such that an “animal” child is transformed into a “human” man without the benefit of practice or routine in these modes of thought and action?

Holt believes that children want to learn, and that their behaviors and choices are fundamentally aimed at learning about the important functional relationships of the world around them. They choose their own goals based on their own interests and then determine what preceding knowledge they must obtain to secure their goals. The schooling method, of which Holt is skeptical, involves sequential learning from the basic to the complex, with no object for the instruction other than to master the material. But this is not interesting to most children, because the learning is divorced from a meaningful context (ie, a problem they personally want to solve) and the structuring of the learning often serves to highlight to a child how little he knows about a given field, an unnecessary bruise to a young person’s self-esteem. The result is that children often invest a lot of energy in avoiding learning, rather than engaging with the material, and what they practice is denying their own values and interests rather than gaining competence in knowledge and systems they have no desire to learn.

The ego is so central to Holt’s understanding of how children learn that it almost defies explanation how absent this concern is from most other pedagogical methods! Where did people come up with the idea that the student’s own fascination with the subject (or lack thereof) is irrelevant to the problem of learning? Why should we think it is optimal to follow any path of instruction which ignores this fundamental element? And who is truly being served by such an approach when it clearly can not be the child himself?

A related danger that Holt discusses is attempts to trick children into learning things, by teaching them without them noticing they’re being taught. If the idea is to teach people even if they don’t want to be taught, and if doing so creates resistance to learning, then it does seem logical to try to sneak and cheat the information into children’s minds. But is that respectful, and should we imagine anything else but more failure from continuing to build on such flawed premises?

Holt’s warning is again startling. Children are not aliens who think completely differently from adults. They are simply differently capable people, and their human capacity for reasoning makes it obvious to them, even when they’re very young, when they’re not being treated on the level. How disrespectful to treat another human being this way, with so little concern for their own values and well-being! Imagine trying to “trick” an adult into learning something without their permission or interest, by asking questions one already knows the answers to, or insinuating that something they don’t consider important is actually quite so. Such a person would consider it demeaning to imply they can’t figure out for themselves what deserves their attention and what does not, or that they’re not sharp enough to know they’re being fooled with, and so it is with children.

This is a rich and dense work with many pithy observations I wish I had highlighted the first time through. The author clearly admires children for their potential and their capability alike, and he helps the reader to see children not as helpless, but as empiricists, experimenters and practitioners. The hardest thing for parents and teachers to internalize from this work is the need for them to exercise self-control in light of their penchant for thinking their interventions in the life of children are so critical to the children’s thriving. It appears to be just the opposite!

Review – Crazy Rich Asians

Crazy Rich Asians

by Kevin Kwan, published 2014

On its surface, Crazy Rich Asians is a sordid story of dysfunction and social positioning within mega-wealthy sorta-nobility Chinese families originating in Singapore. It’s full of flashy outfits and the shocking shopping trips that put them in the characters wardrobes; over-the-top square footage and fully-furnished living arrangements in a part of the world known for nearly inhumane density and some of the highest real estate prices in the world; petty gossip like only those with too much time and money on their hands can engage in; oh, and wonderful, wonderful sounding food. For those reasons, it’s an entertaining read.

But just below the surface (not too far, mind you… these issues are philosophically auxiliary as far as I can tell, not intentionally contemplative like a work of classic literature) lie a series of family-planning and wealth-planning puzzles for the observant reader to consider. In no particular order, and with very minor spoilers, these puzzles are explored more below.

The first puzzle has to do with identity. When one of the main characters finds out that the early story of their family’s history is a fabrication, they are thrown into psychological turmoil and shock, their sense of self seemingly obliterated in a moments revelation. It begs the question “Who are you?” One answer is, you are your history, a series of factual contexts and accumulated decisions made up to any point in time at which you exist. Another answer is, you are whatever you believe you are– if you can convince yourself you are, than you are. This question is important for a few reasons. The first is that the way our brains function on a psychological level may require us to have certain beliefs about ourselves to maintain psychological integrity and thus enable us for other modes of action in the external world. We may be able to “constantly reinvent ourselves”, but only within a narrow band of experience or possibility, beyond that we are driven at a hardware level into anxiety and distress. Another reason this question is important is because it sheds light on how arbitrary our identities can be. If we can operate quite competently and confidently with a certain view of ourselves and our role in the world, even if this viewpoint is built on falsehoods, it suggests that what is important in terms of forming an identity is consistency of story, not accuracy. If someone can convince you you are the rightful king, maybe you are. If you come from a noble family but you’re told you’re a lout, maybe you will be. Where does one find “self” in all of this?

Related to this puzzle is parental relationships and the question, “Do you really want to know everything about your parents?” Each one of us is born into a world our parents have already been living for some time. We don’t know all the choices and ideas they had prior to our arrival and often we receive a filtered list of such information sporadically throughout our lives. We don’t have the ability to query our parents’ true thinking at any given moment and without becoming paranoid and running background checks or doing some sleuthing on them, we’re mostly in a position to accept what they tell us about themselves unless we receive some kind of alarmingly contradictory information that would lead us to question it. Similar to finding out your life might have been a lie, do we want to know who our parents really are? We presume they share the good about themselves with us, do we really want to hear about more of their foibles?

The second puzzle is about intergenerational wealth building. The narrative focuses on Singaporean Chinese families of stupendous wealth. Most of this wealth seems to be owned and controlled by surviving matriarchs whose heyday was the 1930s and 1940s (Gen1). The descendants (Gen2) and their children (Gen 3) appear to be idlers. Sure, some of them have “jobs” and other preoccupations, but none of them have to work and none seem to be contributing anything productive to the family wealth, which appears to be managed professionally by outsiders.

Why don’t rich families prepare future generations to manage their wealth responsibly? When the matriarch dies, what will keep the professional managers loyal, and what will give the surviving descendants the ability to manage these obligations without undue risk? Money is clearly important to these families, as they could give it away or have less of it but they don’t. But there doesn’t appear to be a meaningful attempt to teach the succeeding generations how to contribute to its growth and management.

Related to this is the question of what is the value of fantastic wealth? Although they think of themselves quite highly, the families depicted don’t seem to be better at much of anything that doesn’t involve buying things. In terms of character they have the same flaws and struggles as everyone else. If this wealth can’t make you a better person, or, put another way, you don’t use it to enable greater self-actualization, of what use is it? Ironically, wealth in this story is depicted as not creating conditions by which those who possess it can elevate themselves, but simultaneously it explores the ways wealth changes a person in terms of tastes and behaviors. Here we see not how a person’s values change, but the ways in which their ability to express those values do. If you don’t use it to become a better version of yourself, and you don’t learn how to manage and control it, what logical benefits does wealth offer you?

The final puzzle of the story is the puzzle of permanent capital. As none of the major characters and their families seem to contribute to the generation of their wealth, and none seem capable of doing so, where the wealth comes from and how it manages to persist, especially as it is being consumed at such enormous rates, is a bit of a mystery. Of course, in this story we can only see the families whose wealth has persisted across multiple generations despite all of the above-mentioned conditions and despite the changes in social and economic circumstances over decades. What we can not see are the families whose wealth ran aground over this period, because they won’t factor into a narrative about those who have great wealth except as a tale of warning which never seems to be told. It is amateurish and perhaps speaks to the intelligence or values of the intended reader but the author never provides even a small hint as to where the wealth comes from (oh sure, some new money families introduced here and there are the Such and Suchs of plastics, or the So and Sos of tech).

Though friends with government officials and even extant royalty, the primary families are disclaimed as not being of purely aristocratic extraction or otherwise connected directly to a government-based wealth extraction mechanism. But from where else could such voluminous and seemingly interminable wealth emanate from, especially without influence or concern of the family? If such a source exists in the market (a contradiction in terms at the very least), how is it undiscovered by other market participants and thus immune to competitive factors? How is it financed?

In studying great exceptions there is an honest temptation to find some kind of exploitable rule. But I think it’s ultimately a fool’s errand, because you’re essentially looking at a highly improbable stack of luck and trying to figure out how to emulate something that is amazing that it even exists at all.

Review – The Secret Of Childhood

The Secret of Childhood

by Maria Montessori, published 1936, 1982

If you’re looking for a “how-to” on the Montessori Method, this isn’t it. What this book is is an exploration of the philosophical foundations of Maria Montessori’s view of the child in society, based upon some of her historical experiences and study of related social research.

Although this book was published long ago, Montessori’s revelation appears to be, by and large, still a secret. Sadly, it is not just a cultural secret. Even in the West, and particularly the United States, where her ideas seem to have the strongest following, the parenting and educational mainstreams seem to have done little to absorb Montessori’s insights into both theory and practice. If Montessori was correct in her discovery, then it says something both appalling and demoralizing about the failure of society to integrate such important truths. So, what is this “secret”?

The secret of childhood is that it is a period of time during which the child works, not to assimilate himself into society, but to assimilate himself into himself. We hear echoes of Max Stirner (1806-1856, Germany) in Maria Montessori (1870-1952, Italy), for example, compare Stirner,

school is to be life and there, as outside of it, the self-revelation of the individual is to be the task… only freedom is equality… we need from now on a personal education (not the impressing of convictions)… knowledge must die and rise again as will and create itself anew each day as a free person.

to Montessori,

Adults look upon a child as something empty that is to be filled through their own efforts, as something inert and helpless for which they must do everything, as something lacking an inner guide and in constant need of direction… the adult makes himself the touchstone of what is good and evil in the child. He is infallible, the model upon which the child must be molded… An adult who acts this way… unconsciously suppresses the development of the child’s own personality.

or to Montessori’s son, Mario, from the preface,

Man has discovered flight, he has discovered atomic energy, but he has failed to discover himself.

or to Margaret Stephenson, a Montessori instructor, from the foreword,

How can one learn through group play what it means to be a mother, father, space pilot, dog, when one does not yet know what it mean’s to be one’s self?

This psychic development of the child, a “universal” as Montessori puts it, into an individuated person, the man, unfolds along a predetermined path dictated by nature.

Childhood constitutes the most important element in an adult’s life, for it is in his early years that a man is made.

That is not to say that man’s childhood development is deterministic, but that there is a logic and a succession of predictable stages and events to it, much like a caterpillar becomes a cocoon and then a butterfly.

The place an animal will have in the universe can be seen at birth. We know that one animal will be peaceful since it is a lamb, that another will be fierce because it is a lion cub, that one insect will toil without ceasing since it is an ant, and that another will do nothing but sing in solitude since it is a locust. And just as the lower animals, so the newly born child has latent psychic drives characteristic of its species… A child develops not simply as a member of the human species, but as a person.

And the implication of this fact is that the child, in his childhood, has special needs during this period of development which will allow this process of psychic development to occur without obstruction or injury, ranging from the suitability of his environment, to the tools and instruments he has at his use, to the way he is interacted with and communicated with by adults, who he sees as omnipotent, almost magical, beings of power and authority. (Isn’t it funny to stop for a moment and consider how sure of ourselves and the nature and limits of the adults around us we are, and how truly mysterious any of this was when we first made our way into the world as small children? Just ponder that for a moment if you’re having trouble grasping the significance of Montessori’s “secret”.)

What are some of these differences and needs between children and adults? The first is understanding the significance of work to each. For adults, work is a means to obtain a fixed and known goal, and the general idea is to work efficiently, that is, to get the highest yield in terms of outcome for the smallest amount of resources and energy expended. But for children, the purpose of work is to learn about the self– work is not performed to obtain an income, or to be fed, or to avoid a threat, but rather work is performed to experience the psychic benefit of knowing how to perform the work.

An adult walks to reach some external goal and he consequently heads straight for it… An infant, one the other hand, walks to perfect his own proper functions, and consequently his goal is something creative within himself.

In working, a child applies their intellect to the world, they come to understand their power and ability as a person to influence and change the world more to their liking, a fact that mature adults take for granted.

His hands under the guidance of his intellect transform this environment and thus enable him to fulfill his mission in the world.

Because of this, a child may be seen to work “aimlessly”, or “inefficiently”, or “incompetently”, but this observation is made from the point of view of an adult which is not applicable to the child and their psychic purpose in working. Montessori relates how adults who are finished working are typically tired and in need of rest or recreational stimulation, whereas children who are finished working are exhilarated and self-satisfied at accomplishing whatever it was inside of their psyche that compelled them to perform their work.

Another need is the need for separate property. Children exist in a world created by adults, for the benefit of adults and adults can be capricious with their property and arrangements in ways that are befuddling and intimidating to children. Everything in the child’s world (for example, in the home) belongs to the adults– the furniture, which is sized for the adults; the dishware and glassware and silverware, which is sized for the adults; the books, the clothes, the walls, the art, even the pets!

[An adult is tempted to overvalue his material possessions when they’re being handled by a child, such as with a glass of water being carried by his child.] The adult who does this may even be very wealthy and intent upon increasing his fortunes many times over in order to make his son still more wealthy than himself. But for the moment he esteems a glass as something of greater value than the child’s activity and seeks to prevent its being broken [and so interferes needlessly with the child’s development in stopping him from his activity with the glass].

Montessori describes the adults as “kings”, who may of occasion grant the child a right to temporary use of the king’s property, but never the right to possess the property themselves.

An adult, however high or low he may be, is always a powerful being in comparison with a child.

The child can feel as if it lives only at the mercy and privilege of the king. The child is constantly being instructed and informed how to use something, what to touch and what not to touch, to keep away from this or to go be near that. The child needs some of its own things, in sizes and qualities specific to its uses, so that it may explore and understand and “work” in the world around itself without constantly being in conflict with the adults.

An adult is constantly interrupting the child and breaking into his environment. This powerful being directs the child’s life without ever consulting the child himself. And this lack of consideration makes the child think that his own activities are of no value.

A final need is for adults to appreciate the differences in perceptive faculties of children, who, as Montessori describes, pay attention to details not just different in magnitude, but in kind.

A child’s psychic personality is far different from our own, and it is different in kind and not simply degree.

Adults are accustomed to looking at the world and paying attention to details in a particular way based upon their individual goals, ambitions, professional outlook, educational level, etc. etc. But children often pay attention to details quite differently, and in ways that conflict with adult perceptions or treat them as non-sensical or unimportant.

Children an adults are in possession of two different mental outlooks… Adults frequently attempt to point out ordinary objects to three- or four-year-old children as if they had never seen anything before. But this must have the same effect on a child as one shouting at another whom he thinks to be deaf [who is not so].

An adult may wish to draw a child’s attention to the beach and the ocean, but the child is fascinated by a tiny bug crawling across the sand. Adults are often quick to pass judgment on the child in these moments, as if they are “wrong” for not being interested in what the adult wants them to be interested in, or even questioning their intelligence or development when they seem incapable of taking such an interest. But as with work, observation serves a different purpose for the child than for the adult– it is not to satisfy his desire for recreation, or to attend to a productive goal, but to stimulate his psyche according to these innate, natural needs of his development.

Here are some other interesting quotes I collected:

  • The child is a universal… There is, in reality, only the child of all times, of all races, heir to tradition, hander-on of history, crucible of culture, pathway to peace.
  • The absorption of culture, of customs, of ideas, ideals, of sentiments, feelings, emotions, religion, take place during the period of the absorbent mind, in the child from zero to six.
  • We should try to understand that there is an intelligible reason behind a child’s activities. He does nothing without some reason, some motive… A child does not simply run, jump and handle things without purpose and thus create havoc about the house… Knowledge always precedes movement. When a child wishes to do something, he knows beforehand what it is. [A very Misesian idea!]
  • An adult’s avarice, which makes him jealously defend whatever he owns, is concealed under “the duty of properly educating one’s child.” [What Stirner would refer to as a “spook”, or a mental hobgoblin an adult uses to frighten his own psyche and thus prevent himself for taking ownership over his actions.]
  • When a child moves slowly, an adult feels compelled to intervene by substituting his own activity for that of the child. But in acting thus an adult, instead of assisting a child in his psychic needs, substitutes himself in all the actions which the child would like to carry out by himself.
  • What an adult tells a child remains engraved on his mind as if it had been cut in marble.
  • When a child is disobedient or has a tantrum an adult should always call to mind the conflict and try to interpret it as a defense of some unknown vital activity necessary for the child’s development.
  • Toys furnish a child with an environment that has no particular goal and, as a consequence, they cannot provide it with any real mental concentration but only illusions.
  • Before anyone can assume a responsibility, he must be convinced that he is the master of his own actions and have confidence in himself.

I enjoyed reading this book, it stimulated MY psyche and made an impression upon me in terms of how much more there is to think and know about this subject than what I possess currently. I also enjoyed the archaicness of it, Montessori writes like a civilized person of years gone by, speaking articulately and frankly about the world around her without apology and with much conviction and passion for her subject, something which doesn’t seem to exist anymore in our world of sterile, clinical academics reluctant to take a position on anything of import. But it was not always an easy read and it was fairly repetitious. I will likely come back to the book at some point to re-read certain passages that I found hard to appreciate without an experience of raising a child myself. Yet, I wouldn’t recommend this as an “essential” title for someone looking to up their parenting game unless I already knew they were more philosophical in their approach.

Review – The Dog’s Mind

The Dog’s Mind: Understanding Your Dog’s Behavior

by Bruce Fogle, DVM, MRCVS, published 1992

Peering into the canine mind

If you’ve ever owned a dog, or even just observed one owned by someone else, it seems almost inevitable to ask yourself the question, “What is going on inside that dog’s head right now?”

I grew up with dogs and have fond memories of four different family dogs of different breeds since childhood. But as a child and even a teenager I didn’t spend much time trying to understand the dogs. They were just there, part of the family landscape and in many ways I took them for granted.

Those fond childhood memories influenced my decision almost two years ago to acquire my own dog. This time, my decision was purpose-driven based upon what I understood about dogs and dog breeds, what I hoped for as a lifestyle to be had with my new companion and my own emotional idealism concerning the dog. We ended up buying a pure bred female German Shepherd from a professional breeder who creates showdogs and pets from German working bloodlines. She is a beautiful, intelligent creature to put it mildly.

We spent a considerable amount of time before and after acquiring our puppy studying articles, videos, books and other information at sites like Leerburg.com and others around the web (two other titles which were helpful, amongst many: The Art of Raising A Puppy and How To Be Your Dog’s Best Friend) trying to establish a baseline of knowledge concerning both dog biology and dog psychology to aid the integration of this creature into our home and to improve our chances of training and controlling the animal in a manner beneficial to both parties.

While we’ve been largely successful in this endeavor (so much so that it is hard not to be a bit judgmental towards most of the other dopey, clueless dog owners and dog lovers we come across on a daily basis) the mystery largely remains– what is going on inside that little doggie brain?

The unity of The Dog’s Mind

The author is a practicing veterinarian who I gather may have been an American (or at least was fond of the American revolution at one point, based upon the names he gave to his two Golden Retrievers) but at any rate now lives in the UK. This is a strength of the book because he clearly has personal experience with thousands of dogs of a multitude of breeds and he obviously loves the animal, but it is also a weakness because Mr. Fogle is so intelligent and academically-minded that he often spends a lot of time going into medical and biological minutiae that the average pet owner neither needs to understand (“Here’s a short explanation of DNA sequencing in the dog genome!”) nor is likely to be interested in (“A research study into the effect of X on lab rats showed Y, which may provide interesting insight on the nature of dogs as well.”).

In other words, this is an at-times-top-heavy but otherwise practically-oriented book written by an extremely knowledgeable, experienced and well-read author (read: “scientific”) that explores not dog behavior, or dog psychology but the dog’s mind.

Essentially, Mr. Fogle seeks to explain how

the dog’s mind is a result of instinct, genetics, evolution and selective breeding… hormones influence the mind… and… maternal and peer imprinting and human intervention alter the ways of the dog.

Key ideas here are that the near ancestor of dogs are wolves, a species which inhabits an “opportunist omnivore” ecological niche, and that dogs can never get away from this historical and genetic fact and that despite breed differences which emphasize one characteristic of the dog over another (scent versus eyesight versus aggressiveness versus size, etc.) the mental core of the dog is common to all breeds and can be shaped by humans the same way.

Physiology and psychology

“The Dog’s Mind” is divided into two parts, “The Anatomy and Physiology of the Dog’s Mind” and “The Psychology of the Dog’s Mind”. The first part explores the role of genetics, the “wiring”, size and layout of the dog’s brain, the five senses, the interplay of hormones and the communication strategies of dogs while the second part explores maternal, peer and human imprinting, social behavior, breed differences and finally the effects of age and ill health on the dog’s mind.

Dogs are sentient beings, aware of their own personalities… Dogs dream… They are amazingly perceptive to nuance and observe the most imperceptible changes in us… dogs have been bred to retain the juvenile characteristics of play, exploration and subservience to the leader.

There are so many fascinating insights in this book, far too many to quote them all so I plan to cover some of the more interesting or important ones and sprinkle other quotes without comment as I go.

Speaking of genetics, the author observes that there are more genes which control behavior than there are genes which control “morphology” (the dog’s physical characteristics and appearance) which is part of the reason that there is a large difference in the morphology of an Irish wolfhound and a Chihuahua after generations of selective breeding, yet the “mind” of each animal is quite similar. It also explains why dogs remain so wolflike after thousands of years of domestication and co-habitation with humans. This is so key for dog owners (and the general public!) to understand and yet, tragically, it is not. Most people expect from dogs thought processes and behaviors that are simply unreasonable given the dog’s mind. The dog comes from the wolf, a predator animal, and every dog, no matter how big, small or lovable, continues to think of himself as a predator animal. Like the wolf, the dog is also a pack animal. Amongst modern humans it is popular to be egalitarian and democratically-minded, but to dogs aristocracy and a pecking order is the most natural and desirable system in the world, so much so that attempts to make the dog an “equal” in a human pack can be greatly destabilizing to the point of psycho-somatic derangement.

(Pro tip: if you ever see a “mean” dog that barks/yips at every dog and stranger passerby, you are actually witnessing a situation where the human is unwittingly beta and the dog has designated itself the alpha pack leader and protector… a truly sad and, for the human, completely unwitting state of affairs!)

In the dog’s limbic system, a battle plays out between his instinctive behavior and the negative or positive stimulus humans provide by punishing or rewarding certain behaviors. If we can create a stronger stimulus than the instinct, the limbic system is overridden and we’re able to control the dog’s behavior. A dog that is “uncontrollable” is simply a dog whose owner has not found a sufficiently stimulating punishment or reward to alter behavior. This is important not just for control but trainability– the dog’s mind is most amenable to learning when its interest is aroused which is why positive reinforcement (systems like “marker training“) tend to be the most effective ways to establish long-term behavioral conditioning in the dog’s mind.

Touch is the earliest and possibly the most important of all the canine senses.

The role that senses play in the dog’s mind is another critical piece of the puzzle. When a newborn pup emerges from the womb, its ear canals are closed shut, it can not open its eyes and its wonderful sniffer is fairly ineffective. Touch and sensations of warmth are how it maneuvers itself toward its mother’s teat for its nourishment. This connection to touch remains with the dog its entire life and becomes therefore an important tool of social communication– touch a dog and it feels rewarded, ignore a dog and it feels despondent.

While touch has the biggest social implication, it is smell that is the strongest of the five senses. The book explains that taste is actually fairly restricted for dogs, they basically experience taste as “pleasant”, “indifferent”, and “unpleasant” unlike the human experience of salty, sweet, spicy, bitter, etc. And while a dog’s vision is in many ways superior to a human’s both in terms of distance and operation under varied light conditions, the positioning of the eyes on a dog mean that it is best-adjusted to observing peripheral motion, the “furtive movement” of its prey, rather than focusing on objects directly in front of it. Dogs are also known for their ability to hear sound frequencies humans can not perceive and are even considered to be “musical”, but it is truly the sense of smell that is most developed and differentiated in the dog which means that the dog’s mind primarily experiences the state of reality through smell.

Dogs have around 220 million scent receptors around their nose compared to the average human’s five million.

Smell memories last for life and affect almost all canine behaviors.

The dog uses scent in a number of ways– to sense prey, to sense other dogs, to sense a mating opportunity, etc. The reason dogs seem to forward with humans, sniffing our butts just as they sniff other dogs, is because in a dog the anal glands have developed to give an ID to other dogs. And because smell is so key to the functioning of the dog’s mind, it is the ability to get out of the house and smell things, rather than the exercise, which is most satisfying and important to a dog on a walk. It also means that “the quality of life of a blind dog can still be quite good.”

The chapter on hormones is somewhat technical but one important idea is that in tact male dogs live their entire lives with male sex hormone circulating throughout their body, whereas in tact females only experience the female sex hormone twice a year for a total of four months. This means the volatility of a female dog’s personality is greater than a male’s.

Selective breeding by humans has enhanced the “infantile” vocalizations of dogs. For example, adult dogs rarely whine at each other, but rather at us humans– a learned response. There are 5 primary vocalizations for dogs:

  1. infantile sounds; cry, whimper, whine
  2. warning sounds; bark, growl
  3. eliciting sounds; howl
  4. withdrawal sounds; yelp
  5. pleasure sounds; moan

Dogs also are masters of body language in communicating to one another, and to observant humans, how they are feeling, manipulating the position of their mouths, ears, tails, hackles, front and hind quarters and even their entire bodies to demonstrate a range of emotional experiences. And in dogs, staring is a form of dominance (like physical mounting), only alpha dogs can look directly at other dogs, so when you pet your dog and it looks away it is expressing deference to you, not disinterest.

Dog psychology

When it comes to the developing dog mind, early exposure to mild stress (loud noises, sudden movements, bright lights, etc.) are valuable in creating a stable, even-tempered pet. Dogs are learning all the time and what they are exposed to frequently and at duration (called “flooding”) they learn to tolerate or even accept as natural.

The concept of “imprinting” is also important. There is a key window in the puppy’s development, from around weeks 6-12, during which it is critical the puppy not only be exposed to humans but also to other dogs so that it learns that both are part of its pack. A puppy only exposed to humans becomes fearful and protective around other dogs, and a puppy only exposed to dogs becomes anxious and often untrainable with humans.

Play is a lifelong activity in dogs… as strong in wolves as it is in Yorkshire terriers.

But even with this human imprinting, a dog still thinks of itself as a dog and expects the human to behave as a dog does, participating in group activities, playing, hunting together and sleeping in the same den.

Puppy Aptitude Tests (PAT) have become popular when selecting a pet from a new litter, but there is little research that shows these techniques are successful indicators of long-term behavior other than those which demonstrate aggression or dominance, which tend to persist into adulthood but which are also rare in high levels in the dog population as a whole.

Regarding dog training, it is important to remember that dogs don’t think symbolically, they operate on a “what you see is what you get” basis. They learn three ways:

  1. observation
  2. classical conditioning
  3. operant conditioning

Dogs are also ALWAYS learning. They pay attention to all cause and effect relationships and will expect them to happen consistently in the future once substantiated once unless they are conditioned out of the expectation. This is why, for example, my dog becomes alert and predatory at the corner of my block in front of a house where it once saw a cat on the lawn– it happened one time and is now imprinted in her mind so she expects to see the cat each time and gets aroused in anticipation.

It’s worth quoting Mr. Fogle at length on this point:

Dogs are learning all the time and our objective is to control the stimuli, responses and rewards. We can do so by reinforcing, not reinforcing or punishing the behavior… They learn fastest when their behavior is consistently rewarded… The timing, intensity and intervals of reinforcement all have direct consequences on learned behavior. Reinforcement must be immediate… The object of canine punishment should be to reveal your power, not inflict pain… if a learned behavior is not reinforced, it is eventually lost.

Another important implication of the way dogs are always learning is that they interpret our reactions to their behavior as the control they have over us. If we respond to unwanted behaviors, they see that as their dominance or assertiveness operating. As humans, we must be very thoughtful about how we respond to all dog behaviors, good and bad, at least as far as we morally categorize them as such.

There was also an interesting list in the book showing tendency of behaviors between male and female, with more likely in females at the top and more likely in males at the bottom:

  • Obedience training
  • Housebreaking ease
  • Affection demand
  • Watchdog barking (baselined at 0)
  • Excessive barking (baselined at 0)
  • Excitability (baselined at 0)
  • Playfulness
  • Destructiveness
  • Snapping at children
  • Territory defense
  • General activity
  • Aggression with dogs
  • Dominance over owner

I also thought it was interesting that the author noted that most dog breeds are similar in intelligence although their capacity to excel in certain roles and functions is quite different. Many people tend to think of very small and very large breeds as “dumb” dogs not worth training.

Conclusion

As I said, there is a ton of information in this book. I had read a lot of it in other places before I got to this book, and I found some of the detailed explanations of biological processes a bit overwhelming and beyond my interest in reading the book but that doesn’t change the fact that this is chock full of info. In fact, there is a very handy appendix with training tips for some of the primary behaviors every pet dog should have (come, sit, stay, down, etc.) and the latter half of the book dealing with dog psychology includes not only diagnoses of various forms of dog aggression but also suggestions on how to prevent or treat their development as behavior traits, which could be helpful to many people who think they “just have an aggressive/mean dog.”

Dogs don’t think and behave as we like them to, they think and behave as they do, and what they do is strongly influenced by their genetic heritage as wolves as well as the early experiences they have in the litter and in our care. If we want to have enjoyable relationships with our dogs and other people’s dogs which are increasingly prevalent parts of our society, we would do well to become familiar with the essential knowledge contained in books like “The Dog’s Mind.” It will fundamentally change our relationship with these creatures and may even leave us appreciating, rather than bemoaning, our biological differences.

Review – Quantitative Value

Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors + website

by Wesley R. Gray and Tobias E. Carlisle, published 2012

The root of all investors’ problems

In 2005, renowned value investing guru Joel Greenblatt published a book that explained his Magic Formula stock investing program– rank the universe of stocks by price and quality, then buy a basket of companies that performed best according to the equally-weighted measures. The Magic Formula promised big profits with minimal effort and even less brain damage.

But few individual investors were able to replicate Greenblatt’s success when applying the formula themselves. Why?

By now it’s an old story to anyone in the value community, but the lesson learned is that the formula provided a ceiling to potential performance and attempts by individual investors to improve upon the model’s picks actually ended up detracting from that performance, not adding to it. There was nothing wrong with the model, but there was a lot wrong with the people using it because they were humans prone to behavioral errors caused by their individual psychological profiles.

Or so Greenblatt said.

Building from a strong foundation, but writing another chapter

On its face, “Quantitative Value” by Gray and Carlisle is simply building off the work of Greenblatt. But Greenblatt was building off of Buffett, and Buffett and Greenblatt were building off of Graham. Along with integral concepts like margin of safety, intrinsic value and the Mr. Market-metaphor, the reigning thesis of Graham’s classic handbook, The Intelligent Investor, was that at the end of the day, every investor is their own worst enemy and it is only by focusing on our habit to err on a psychological level that we have any hope of beating the market (and not losing our capital along the way), for the market is nothing more than the aggregate total of all psychological failings of the public.

It is in this sense that the authors describe their use of “quantitative” as,

the antidote to behavioral error

That is, rather than being a term that symbolizes mathematical discipline and technical rigor and computer circuits churning through financial probabilities,

It’s active value investing performed systematically.

The reason the authors are beholden to a quantitative, model-based approach is because they see it as a reliable way to overcome the foibles of individual psychology and fully capture the value premium available in the market. Success in value investing is process-driven, so the two necessary components of a successful investment program based on value investing principles are 1) choosing a sound process for identifying investment opportunities and 2) consistently investing in those opportunities when they present themselves. Investors cost themselves precious basis points every year when they systematically avoid profitable opportunities due to behavioral errors.

But the authors are being modest because that’s only 50% of the story. The other half of the story is their search for a rigorous, empirically back-tested improvement to the Greenblattian Magic Formula approach. The book shines in a lot of ways but this search for the Holy Grail of Value particularly stands out, not just because they seem to have found it, but because all of the things they (and the reader) learn along the way are so damn interesting.

A sampling of biases

Leaning heavily on the research of Kahneman and Tversky, Quantitative Value offers a smorgasbord of delectable cognitive biases to choose from:

  • overconfidence, placing more trust in our judgment than is due given the facts
  • self-attribution bias, tendency to credit success to skill, and failure to luck
  • hindsight bias, belief in ability to predict an event that has already occurred (leads to assumption that if we accurately predicted the past, we can accurately predict the future)
  • neglect of the base case and the representativeness heuristic, ignoring the dependent probability of an event by focusing on the extent to which one possible event represents another
  • availability bias, heavier weighting on information that is easier to recall
  • anchoring and adjustment biases, relying too heavily on one piece of information against all others; allowing the starting point to strongly influence a decision at the expense of information gained later on

The authors stress, with numerous examples, the idea that value investors suffer from these biases much like anyone else. Following a quantitative value model is akin to playing a game like poker systematically and probabilistically,

The power of quantitative investing is in its relentless exploitation of edges

Good poker players make their money by refusing to make expensive mistakes by playing pots where the odds are against them, and shoving their chips in gleefully when they have the best of it. QV offers the same opportunity to value investors, a way to resist the temptation to make costly mistakes and ensure your chips are in the pot when you have winning percentages on your side.

A model development

Gray and Carlisle declare that Greenblatt’s Magic Formula was a starting point for their journey to find the best quantitative value approach. However,

Even with a great deal of data torture, we have not been able to replicate Greenblatt’s extraordinary results

Given the thoroughness of their data collection and back-testing elaborated upon in future chapters, this finding is surprising and perhaps distressing for advocates of the MF approach. Nonetheless, the authors don’t let that frustrate them too much and push on ahead to find a superior alternative.

They begin their search with an “academic” approach to quantitative value, “Quality and Price”, defined as:

Quality, Gross Profitability to Total Assets = (Revenue – Cost of Goods Sold) / Total Assets

Price, Book Value-to-Market Capitalization = Book Value / Market Price

The reasons for choosing GPA as a quality measure are:

  • gross profit measures economic profitability independently of direct management decisions
  • gross profit is capital structure neutral
  • total assets are capital structure neutral (consistent w/ the numerator)
  • gross profit better predicts future stock returns and long-run growth in earnings and FCF

Book value-to-market is chosen because:

  • it more closely resembles the MF convention of EBIT/TEV
  • book value is more stable over time than earnings or cash flow

The results of the backtested horserace between the Magic Formula and the academic Quality and Price from 1964 to 2011 was that Quality and Price beat the Magic Formula with CAGR of 15.31% versus 12.79%, respectively.

But Quality and Price is crude. Could there be a better way, still?

Marginal improvements: avoiding permanent loss of capital

To construct a reliable quantitative model, one of the first steps is “cleaning” the data of the universe being examined by removing companies which pose a significant risk of permanent loss of capital because of signs of financial statement manipulation, fraud or a high probability of financial distress or bankruptcy.

The authors suggest that one tool for signaling earnings manipulation is scaled total accruals (STA):

STA = (Net Income – Cash Flow from Operations) / Total Assets

Another measure the authors recommend using is scaled net operating assets (SNOA):

SNOA = (Operating Assets – Operating Liabilities) / Total Assets

Where,

OA = total assets – cash and equivalents

OL = total assets – ST debt – LT debt – minority interest – preferred stock – book common equity

They stress,

STA and SNOA are not measures of quality… [they] act as gatekeepers. They keep us from investing in stocks that appear to be high quality

They also delve into a number of other metrics for measuring or anticipating risk of financial distress or bankruptcy, including a metric called “PROBMs” and the Altman Z-Score, which the authors have modified to create an improved version of in their minds.

Quest for quality

With the risk of permanent loss of capital due to business failure or fraud out of the way, the next step in the Quantitative Value model is finding ways to measure business quality.

The authors spend a good amount of time exploring various measures of business quality, including Warren Buffett’s favorites, Greenblatt’s favorites and those used in the Magic Formula and a number of other alternatives including proprietary measurements such as the FS_SCORE. But I won’t bother going on about that because buried within this section is a caveat that foreshadows a startling conclusion to be reached later on in the book:

Any sample of high-return stocks will contain a few stocks with genuine franchises but consist mostly of stocks at the peak of their business cycle… mean reversion is faster when it is further from its mean

More on that in a moment, but first, every value investor’s favorite subject– low, low prices!

Multiple bargains

Gray and Carlisle pit several popular price measurements against each other and then run backtests to determine the winner:

  • Earnings Yield = Earnings / Market Cap
  • Enterprise Yield(1) = EBITDA / TEV
  • Enterprise Yield(2) = EBIT / TEV
  • Free Cash Flow Yield = FCF / TEV
  • Gross Profits Yield = GP / TEV
  • Book-to-Market = Common + Preferred BV / Market Cap
  • Forward Earnings Estimate = FE / Market Cap

The result:

the simplest form of the enterprise multiple (the EBIT variation) is superior to alternative price ratios

with a CAGR of 14.55%/yr from 1964-2011, with the Forward Earnings Estimate performing worst at an 8.63%/yr CAGR.

Significant additional backtesting and measurement using Sharpe and Sortino ratios lead to another conclusion, that being,

the enterprise multiple (EBIT variation) metric offers the best risk/reward ratio

It also captures the largest value premium spread between glamour and value stocks. And even in a series of tests using normalized earnings figures and composite ratios,

we found the EBIT enterprise multiple comes out on top, particularly after we adjust for complexity and implementation difficulties… a better compound annual growth rate, higher risk-adjusted values for Sharpe and Sortino, and the lowest drawdown of all measures analyzed

meaning that a simple enterprise multiple based on nothing more than the last twelve months of data shines compared to numerous and complex price multiple alternatives.

But wait, there’s more!

The QV authors also test insider and short seller signals and find that,

trading on opportunistic insider buys and sells generates around 8 percent market-beating return per year. Trading on routine insider buys and sells generates no additional return

and,

short money is smart money… short sellers are able to identify overvalued stocks to sell and also seem adept at avoiding undervalued stocks, which is useful information for the investor seeking to take a long position… value investors will find it worthwhile to examine short interest when analyzing potential long investments

This book is filled with interesting micro-study nuggets like this. This is just one of many I chose to mention because I found it particularly relevant and interesting to me. More await for the patient reader of the whole book.

Big and simple

In the spirit of Pareto’s principle (or the 80/20 principle), the author’s of QV exhort their readers to avoid the temptation to collect excess information when focusing on only the most important data can capture a substantial part of the total available return:

Collecting more and more information about a stock will not improve the accuracy of our decision to buy or not as much as it will increase our confidence about the decision… keep the strategy austere

In illustrating their point, they recount a funny experiment conducted by Paul Watzlawick in which two subjects oblivious of one another are asked to make rules for distinguishing between certain conditions of an object under study. What the participants don’t realize is that one individual (A) is given accurate feedback on the accuracy of his rule-making while the other (B) is fed feedback based on the decisions of the hidden other, invariably leading to confusion and distress. B comes up with a complex, twisted rationalization for his  decision-making rules (which are highly inaccurate) whereas A, who was in touch with reality, provides a simple, concrete explanation of his process. However, it is A who is ultimately impressed and influenced by the apparent sophistication of B’s thought process and he ultimately adopts it only to see his own accuracy plummet.

The lesson is that we do better with simple rules which are better suited to navigating reality, but we prefer complexity. As an advocate of Austrian economics (author Carlisle is also a fan), I saw it as a wink and a nod toward why it is that Keynesianism has come to dominate the intellectual climate of the academic and political worlds despite it’s poor predictive ability and ferociously arbitrary complexity compared to the “simplistic” Austrian alternative theory.

But I digress.

Focusing on the simple and most effective rules is not just a big idea, it’s a big bombshell. The reason this is so is because the author’s found that,

the Magic Formula underperformed its price metric, the EBIT enterprise multiple… ROC actually detracts from the Magic Formula’s performance [emphasis added]

Have I got your attention now?

The trouble is that the Magic Formula equally weights price and quality, when the reality is that a simple price metric like buying at high enterprise value yields (that is, at low enterprise value multiples) is much more responsible for subsequent outperformance than the quality of the enterprise being purchased. Or, as the authors put it,

the quality measures don’t warrant as much weight as the price ratio because they are ephemeral. Why pay up for something that’s just about to evaporate back to the mean? […] the Magic Formula systematically overpays for high-quality firms… an EBIT/TEV yield of 10 percent or lower [is considered to be the event horizon for “glamour”]… glamour inexorably leads to poor performance

All else being equal, quality is a desirable thing to have… but not at the expense of a low price.

The Joe the Plumbers of the value world

The Quantitative Value strategy is impressive. According to the authors, it is good for between 6-8% a year in alpha, or market outperformance, over a long period of time. Unfortunately, it is also, despite the emphasis on simplistic models versus unwarranted complexity, a highly technical approach which is best suited for the big guys in fancy suits with pricey data sources as far as wholesale implementation is concerned.

So yes, they’ve built a better mousetrap (compared to the Magic Formula, at least), but what are the masses of more modest mice to do?

I think a cheap, simplified Everyday Quantitative Value approach process might look something like this:

  1. Screen for ease of liquidity (say, $1B market cap minimum)
  2. Rank the universe of stocks by price according to the powerful EBIT/TEV yield (could screen for a minimum hurdle rate, 15%+)
  3. Run quantitative measurements and qualitative evaluations on the resulting list to root out obvious signals to protect against risk of permanent loss by eliminating earnings manipulators, fraud and financial distress
  4. Buy a basket of the top 25-30 results for diversification purposes
  5. Sell and reload annually

I wouldn’t even bother trying to qualitatively assess the results of such a model because I think that runs the immediate and dangerous risk which the authors strongly warn against of our propensity to systematically detract from the performance ceiling of the model by injecting our own bias and behavioral errors into the decision-making process.

Other notes and unanswered questions

“Quantitative Value” is filled with shocking stuff. In clarifying that the performance of their backtests is dependent upon particular market conditions and political history unique to the United States from 1964-2011, the authors make reference to

how lucky the amazing performance of the U.S. equity markets has truly been… the performance of the U.S. stock market has been the exception, not the rule

They attach a chart which shows the U.S. equity markets leading a cohort of long-lived, high-return equity markets including Sweden, Switzerland, Canada, Norway and Chile. Japan, a long-lived equity market in its own right, has offered a negative annual return over its lifetime. And the PIIGS and BRICs are consistent as a group in being some of the shortest-lifespan, lowest-performing (many net negative real returns since inception) equity markets measured in the study. It’s also fascinating to see that the US, Canada, the UK, Germany, the Netherlands, France, Belgium, Japan and Spain all had exchanges established approximately at the same time– how and why did this uniform development occur in these particular countries?

Another fascinating item was Table 12.6, displaying “Selected Quantitative Value Portfolio Holdings” of the top 5 ranked QV holdings for each year from 1974 through 2011. The trend in EBIT/TEV yields over time was noticeably downward, market capitalization rates trended upward and numerous names were also Warren Buffett/Berkshire Hathaway picks or were connected to other well-known value investors of the era.

The authors themselves emphasized that,

the strategy favors large, well-known stocks primed for market-beating performance… [including] well-known, household names, selected at bargain basement prices

Additionally, in a comparison dated 1991-2011, the QV strategy compared favorably in a number of important metrics and was superior in terms of CAGR with vaunted value funds such as Sequoia, Legg Mason and Third Avenue.

After finishing the book, I also had a number of questions that I didn’t see addressed specifically in the text, but which hopefully the authors will elaborate upon on their blogs or in future editions, such as:

  1. Are there any reasons why QV would not work in other countries besides the US?
  2. What could make QV stop working in the US?
  3. How would QV be impacted if using lower market cap/TEV hurdles?
  4. Is there a market cap/TEV “sweet spot” for the QV strategy according to backtests? (the authors probably avoided addressing this because they emphasize their desire to not massage the data or engage in selection bias, but it’s still an interesting question for me)
  5. What is the maximum AUM you could put into this strategy?
  6. Would more/less rebalancing hurt/improve the model’s results?
  7. What is the minimum diversification (number of portfolio positions) needed to implement QV effectively?
  8. Is QV “businesslike” in the Benjamin Graham-sense?
  9. How is margin of safety defined and calculated according to the QV approach?
  10. What is the best way for an individual retail investor to approximate the QV strategy?

There’s also a companion website for the book available at: www.wiley.com/go/quantvalue

Conclusion

I like this book. A lot. As a “value guy”, you always like being able to put something like this down and make a witty quip about how it qualifies as a value investment, or it’s intrinsic value is being significantly discounted by the market, or what have you. I’ve only scratched the surface here in my review, there’s a ton to chew on for anyone who delves in and I didn’t bother covering the numerous charts, tables, graphs, etc., strewn throughout the book which serve to illustrate various concepts and claims explored.

I do think this is heady reading for a value neophyte. And I am not sure, as a small individual investor, how suitable all of the information, suggestions and processes contained herein are for putting into practice for myself. Part of that is because it’s obvious that to really do the QV strategy “right”, you need a powerful and pricey datamine and probably a few codemonkeys and PhDs to help you go through it efficiently. The other part of it is because it’s clear that the authors were really aiming this book at academic and professional/institutional audiences (people managing fairly sizable portfolios).

As much as I like it, though, I don’t think I can give it a perfect score. It’s not that it needs to be perfect, or that I found something wrong with it. I just reserve that kind of score for those once-in-a-lifetime classics that come along, that are infinitely deep and give you something new each time you re-read them and which you want to re-read, over and over again.

Quantitative Value is good, it’s worth reading, and I may even pick it up, dust it off and page through it now and then for reference. But I don’t think it has the same replay value as Security Analysis or The Intelligent Investor, for example.

Review – The Intelligent Investor

The Intelligent Investor: A Book Of Practical Counsel; The Definitive Book On Value Investing

by Benjamin Graham, published 1973, 2003, 2006

All you need to know about intelligent investing

Graham’s layman’s manual for thoughtful investing in common stocks and bonds is a long book, chock full of useful theory and wisdom-gained-by-experience as well as numerous “case studies” which serve to illustrate Graham’s points. While it’s all worth considering, the truth is that certain parts of the book shine more brightly than others and, following the 80/20 principle, are clearly more valuable overall.

Starting out

The Intelligent Investor is of course a practical guide to sound investment, but it is also a work of philosophy. Buried throughout the book are invaluable caveats that are easy to overlook yet deserve to get full billing because they can spare an amateur a lot of headaches down the road. In the book’s introduction, there are two such provisos quite nearby one another, the first being,

be prepared to experience significant and perhaps protracted falls as well as rises in the value of [your] holdings

and the second being,

while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster

Subtle, but profound, these two warnings are Graham’s opening salvo on the subject of investor psychology, or more accurately, the investor’s own psychology. It will be a common thread running throughout TII— your biggest risk in investing is yourself and your psychological reaction to events impacting your portfolio.

Translating the first message, Graham is trying to gird the investor for the inevitabilities of the market, where volatility is constant in both directions. The key, as you will see, is to master volatility by recognizing that the upward variety is not necessarily proof of a good decision and the downward variety is not punishment but an opportunity to buy at bargain prices.

The second message is even more important– successful investing requires an even-keeled temperament and reasonable expectations about long-term success. The game is about expecting little and learning to be pleasantly surprised, rather than expecting a lot and constantly being disappointed. Most of your fellow market participants are excitable folks and their optimistic expectations will work with yours to crowd out any chance at realizing value, while you’ll always have plenty of room to maneuver on your own if you seek out the waters everyone of which everyone else has become bored.

The last warning is to be consistent and disciplined, to never abandon your principles in dire times because that is in fact when they become most valuable:

Through all their vicissitudes and casualties, as earth-shaking as they were unforeseen, it remained true that sound investment principles produced generally sound results

This is again a psychological appeal. When everyone else is losing their shirts, and their minds, forgetting what they’re doing and why, it will pay the long-term investor great dividends to be mindful of who he is and by what principles he invests as his conservatism is always in due time rewarded.

Security analysis 101

While the best treatment of Graham’s principles of security analysis are given in great detail in his treatise of the same name, [amazon text=Security Analysis&asin=0070140650], The Intelligent Investor does come with several basic recommendations on how to perform basic security analysis for issues under consideration for inclusion in one’s portfolio.

Bond analysis

The key to bond investing is interest coverage, as without it a bond is in default and its principal value is imperiled. Therefore, the primary analytical factor is the number of times total interest charges have been covered by available earnings in years past. Typically two values are consulted:

  1. average coverage for a period of years (7)
  2. minimum coverage in the poorest year

Graham recommends 4x for public utilities, 5x for transportation companies, 7x for industrials and 5x for retail concerns, before income taxes on an average of 7 years basis, and 3x, 4x, 5x and 4x, respectively, measured by the poorest year.

On an after-tax basis, Graham recommends 2.65x for public utilities, 3.2x for transportation companies, 4.3x for industrials, and 3.2x for retail companies on an average of 7 years basis, and 2.1x, 2.65x, 3.2x and 2.65x, respectively, measured by the poorest year.

Additional factors for consideration are:

  1. size of the enterprise – something large and robust, so that depletions in revenue do not imperil the business as a whole
  2. equity ratio – the market price of equity versus the total debt, which shows the amount of “cushion” for losses standing in front of the debt
  3. property value – this is the asset value on the balance sheet, though “experience has shown that in most cases safety resides in the earning power”

Stock analysis

Some basic principles of stock selection and analysis are considered in more detail below, based upon whether one is determined to be a defensive or an enterprising investor. For now, it is sufficient to quote Graham on the subject in the following manner:

The investor can not have it both ways. He can be imaginative and play for the big profits that are the reward for the vision proved sound by the event; but then he must run a substantial risk of major or minor miscalculation. Or he can be conservative, and refuse to pay more than a minor premium for possibilities as yet unproved; but in that case he must be prepared for the later contemplation of golden opportunities for gone

In essence, Graham is outlining the philosophy of “growth” versus “value” investing and stock analysis– attempting to forecast the future, or being content one is not paying too much for what he’s got based on an assessment of the past.

Keeping the shirt you have: the defensive investor

In Graham’s mind, there are two kinds of investors– the defensive investor, who is passive and seeks primarily to protect his capital, and the enterprising investor, who treats his investing like a professional business and expects similarly profitable results for his efforts. First, let’s talk about the defensive investor.

The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition

Specifically, Graham lists 4 criteria for selecting common stocks for the defensive investor’s portfolio:

  1. diversification – minimum of 10, maximum of 30 separate issues
  2. standing – companies which are large, prominent and conservatively financed (over $10B mkt cap and in the top third or quarter of their industry by market share or some other competitive metric)
  3. dividends – a long record of continuous payments
  4. price – no more than 25x avg earnings of past 7 yrs, nor 20x LTM earnings

Additionally, Graham warns against excessive trading or portfolio turnover:

if his list has been competently selected in the first instance, there should be no need for frequent or numerous changes

Graham also defines risk early on, saying,

the risk attached to an ordinary commercial business is measured by the chance of its losing money

and that further, a defensive investor should never compromise their standards of safety and quality in order to “make some extra income.” Safety first, income/returns second, or you’re likely to wind up with neither in the long run.

In terms of selecting individual stocks for the defensive investor’s portfolio, Graham suggests 7 criteria:

  1. adequate size of enterprise – generally speaking, small companies are excluded and medium size companies are included if their market/industry position is robust
  2. sufficiently strong financial condition – 2:1 current ratio, and LT debt < net current assets (working capital)
  3. earnings stability – some earnings for the common stock in each year over the past decade
  4. dividend record – uninterrupted payments for the past 20 years
  5. earnings growth – minimum of 1/3 increase in per-share earnings in the past ten years using three year average at the beginning and end
  6. moderate P/E – no more than 15x avg earnings of past 3 years
  7. moderate P/A – price should be < 150% of TBV, though may be higher if earnings multiplier is below 15, never to be greater as a combined ratio than 22.5 ( P/E * P/B <= 22.5)

The purpose is to eliminate companies which are: too small, with a weak financial position, with earnings deficits or with inconsistent dividend histories. In general, these factors should combine to create a stock portfolio which, in the aggregate, has an earnings yield (earnings/price) at least as high as the current high-grade bond rate.

At all times, remember that the defensive investor is

not willing to accept the prospects and promises of the future as compensation for a lack of sufficient value in hand

and that, generally speaking, rather than emphasizing the “best” stocks,

let him emphasize diversification more than individual selection

Making more and better shirts: the enterprising investor

Like the defensive investor, Graham counsels the enterprising investor to think firstly of not losing what they’ve got. But in this sense, the enterprising investor has a new tool in his kit that expands his realm of possible investment options while still maintaining safety of principal– the search for “bargain” priced opportunities, the idea here being that the price being offered for a security is a steep discount (generally 30% or greater) than the indicated “intrinsic” or underlying value of the security itself based upon its asset or earnings power fundamentals (with any luck, both).

About bonds and preferred stocks, Graham suggests that preferreds never be bought without at least a 30% discount, and a similar discount on a high-yield bond. More importantly,

experience clearly shows that it is unwise to buy a bond or preferred which lacks adequate security merely because the yield is attractive […] it is bad business to accept an acknowledged possibility of a loss of principal in exchange for a mere 1 or 2% of additional yearly income

About IPOs, Graham says to never touch them, however, busted IPOs can present interesting opportunities later on down the line:

Some of these issues may prove excellent buys– a few years later, when nobody wants them and they can be had at a small fraction of their true worth

With regards to selecting equity securities, Graham lays out three “recommended fields” for enterprising investors:

  1. large cap contrarianism
  2. “bargain” issues
  3. special situations

Digging in further, let’s take a closer look at large cap contrarianism. The idea here is to focus on companies that are well-known but are currently experiencing an earnings hiccup or some other negative news or general investor boredom that leaves them unpopular and trading at a lower than average multiple. The value in these companies are that,

they have the resources in capital and brain power to carry them through adversity and back to a satisfactory earnings base [and] the market is likely to respond with reasonable speed to any improvement shown

A good example of this principle in practice would be a situation such as buying well-known, large cap companies whose shares had strongly sold off during the financial panic of late 2008, early 2009.

According to Graham, a bargain issue is one in which the indicated value is 50% higher than the current price. Bargains can be detected one of two ways, either by estimating future earnings potential and applying an appropriate multiple and comparing this to current trading price for shares, or else by studying the value of the business for a private owner, which involves particular emphasis on the value of the assets (or the tangible book value of the shares).

For an earnings-based bargain, Graham adds some further criteria, such as:

he should require an indication of at least reasonable stability in earnings over the past decade or more — ie, no year of earnings deficit — plus sufficient size and financial strength to meet possible setbacks in the future

with the ideal being a large, prominent company selling below its past average price and P/E multiple.

Special situations encapsulate a range of investment activities, from liquidations (workouts), to hedging and merger arbitrage activities. While Graham sees this area as one offering special rewards to dedicated and knowledgeable investors, he advises that the trend is one towards increasing professionalization and thus even the enterprising investor is best to leave this area alone unless he has special confidence and competence in the area.

Of special emphasis is the idea of focus and dedication, that is to say, one is either an enterprising investor or a defensive one, but not some of both:

The aggressive investor must have a considerable knowledge of security values– enough, in fact, to warrant viewing his security operations as equivalent to a business enterprise. There is no room in this philosophy for a middle ground, or a series of gradations, between passive and aggressive status. Many, perhaps most, investors seek to place themselves in such an intermediate category; in our opinion that is a compromise that is more likely to produce disappointment than achievement

When considering individual stock selections for the enterprising investors portfolio, Graham reminds the reader that

Extremely few companies have been able to show a high rate of uninterrupted growth for long periods of time. Remarkably few, also, of the larger companies suffer ultimate extinction

To the last point, it is fascinating to see in the footnote commentary by Jason Zweig how many of Graham’s various example companies used throughout the book disappeared not due to bankruptcy, but because they were at some point acquired and absorbed wholesale into the operations of another business.

Several categories of equity selection stand out as particularly valuable for the enterprising investor in Graham’s eyes:

  1. arbitrages – purchase of one security and simultaneous sale of one or more other securities into which it is to be exchanged under a plan of reorganization, merger or the like
  2. liquidations – purchase of shares which are to receive one or more cash payments in liquidation of the companies assets; should present a minimum of 20% annual return w/ 80% probability of working out or higher
  3. related hedges – purchase of convertible bonds or convertible preferred shares and simultaneous sale of the common stock into which they are exchangeable
  4. NCAV – 2/3 or less of net current asset value (current assets – TOTAL liabilities); portfolios should have wide diversification, often of 100 securities or more, and require patience
  5. contrarian cyclical investing – buying important cyclical enterprises when the current situation is unfavorable, near-term prospects are poor and the low price fully reflects the current pessimism

Graham also recommended a special set of 5 criteria for selecting “bargain” issues of small or less well-known enterprises, which can be generated from lists from a stock guide or a stock screen beginning with companies trading for a P/E multiple of 9 or less:

  1. financial condition – current ratio of 1.5:1 and debt <= 110% of working capital
  2. earnings stability – no deficit in the last five years
  3. dividend record – some current dividend
  4. earnings growth – last year’s earnings greater than 5 years ago
  5. price – less than 120% of TBV

Graham notes that diversity is key to safety in these operations and such companies should be bought on a “group basis”.

A balancing act: the portfolio

As a broad strategic principle, Graham recommended that defensive and enterprising investors alike seek to allocate a minimum of 25% and a maximum of 75% of their portfolio into stocks and the remaining amount into bonds. In most cases, an even 50-50 split is recommended. The rule of thumb used to guide allocations above or below 50% is that, as the investor determines the “general price level” of the market to be higher than is prudent, he should allocate toward 75% bonds and 25% stocks, whereas when he determines this price level to be much lower than is reasonable (say, in the midst of a bear market), he should allocate toward 75% stocks and 25% bonds.

As Graham says on page 197,

the chief advantage, perhaps, is that such a formula will give him something to do

Remember, you are your biggest risk. Graham was concerned that without “something to do”, an investor might “to do” his portfolio to death with over activity, over-thought or over-worry.

This is a useful insight, but is Graham’s portfolio balancing technique still valid in today’s era of higher inflation risks?

Without stepping on the maestro’s toes too much in saying this, my thinking is that it is increasingly less valid. As Graham himself warns throughout the book, bonds provide no protection against inflation and, while inflation is not “good” for stocks in real terms, the ability to participate in increased earnings is at least better than having a fixed coupon payment in an inflationary environment.

In this sense, an allocation toward 100% stocks makes more sense, assuming we are entering a period of protracted inflationary pressures such as we are.

That being said, Graham’s warning about having something to do is still worth considering. Having kicked the legs out from under the “rebalancing act(ivity)”, perhaps a good substitute would be a continual turning over of rocks in the search for new investment ideas for the enterprising investor. For the defensive investor, the best course of action may be to enjoy the benefits of doing something through dollar-cost averaging, that is, making a little bit of his total intended investment each month or quarter rather than all at once. Another idea might be to allocate 10 or 15% of his portfolio into a MMF or equivalent when he feels the market is rising beyond prudent levels. But the thing that has never sat right with me about Graham’s reallocation technique is that, while in principle it makes sense, in practice it comes down to base attempts at market-timing that always end up generating unsatisfactory results.

Better to focus on Graham’s other major portfolio strategy tenet, which is diversification. Graham is a supporter of diversification for defensive and enterprising investors alike, mostly because it can serve to shield them from their own ignorance or over-enthusiasm. More specifically, many of Graham’s favored techniques (such as special situations, net-nets and bargain securities), while bearing overall pleasing risk/reward balances, nevertheless never bring certainty of either one and for this reason he believes developing a diversified portfolio of such opportunities is the best way for an investor to protect themselves from permanently losing a large part of their capital on one idea.

Saving the best for last: Mr. Market and the Margin of Safety concept

Mr. Market-mania

Markets are made up of people, and people are emotionally volatile. As a result, financial markets are volatile as well. While the vast majority of the time prices tend to move slightly above and slightly below an established trend line, at other times they can swing wildly off course in either direction:

the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent one third [ X * 1.5 * .66 = ~X] or more from their high point at various periods in the next five years

Graham also warns against what might be termed the Paradox Of Market Goodwill:

The better a company’s record and prospects, the less relationship the price of its shares will have to their book value. But the greater the premium above book value, the less certain the basis of determining its intrinsic value–ie, the more this “value” will depend on the changing moods and measurements of the stock market

In Graham’s mind, the solution is to

concentrate on issues selling at a reasonably close approximation to their tangible-asset value– say, at not more than one-third above that figure [130% of TBV]

as a general principle of careful investing for the defensive investor. But there is more. Graham represents additional criteria based on the consideration of the firm’s earnings power, outlining what value-blogger Nate Tobik of Oddball Stocks likes to call the “two pillar” method:

A stock does not become a sound investment merely because it can be bought at close to its asset value. The investor should demand, in addition, a satisfactory ratio of earnings to price, a sufficiently strong financial position, and the prospect that its earnings will at least be maintained over the years

In terms of mastering an investor’s own psychology when facing the market, asset values reign supreme, however, because

the investor with a stock portfolio having such book values behind it can take a much more independent and detached view of stock-market fluctuations than those who have paid high multipliers of both earnings and tangible assets. As long as the earnings power of his holdings remains satisfactory, he can give as little attention as he pleases to the vagaries of the stock market. More than that, at times he can use these vagaries to play the master game of buying low and selling high

By Graham’s reasoning, buying a stock close to book value puts him in the same position as an individual offered an opportunity to buy into a private business’s book. Because he has paid a fair, businessman’s price, he doesn’t have to worry about what someone else thinks of his ownership stake, only the operating performance and financial strength of his chosen enterprise.

From a psychological standpoint, it is the high ground and much sought after.

But what is this “master game” of which Graham speaks? It is nothing more than the most masterly metaphor of the entire investing world, Mr. Market.

The idea of Mr. Market is that of a manic depressive business partner who on any given day may offer to buy your stake in the joint business for far more than you think it’s worth, or to sell you his stake for far less than you think it’s worth. The key to taking advantage of Mr. Market is to avoid trying to guess and anticipate why his mood ever suits him, instead relying on your own judgment and thinking about the value of the underlying enterprise regardless of Mr. Market’s various mood swings.

It’s worth quoting Graham at length on this subject:

The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgement

Further:

the existence of a quoted market gives the investor certain options that he does not have if his security is unquoted. But it does not impose the current quotation on an investor who prefers to take his idea of value from some other source [such as his own study of the fundamentals]

[…]

price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies

In other words, once you have made your investment, the only value of further quotations is to be appraised of another opportunity to buy (if prices decline sharply from that point) or of an opportunity to sell at a profit (if prices rise sharply from that point).

The rest of the time, you can judge the soundness of your decision by studying whether the operating performance of the business plays out according to your expectations. If the underlying business performs as you anticipated over a long period of time, you only need wait for the market to recognize your good judgment. However, if the business steadily deteriorates in a surprising fashion, you may have a basis upon which to second-guess your original judgment. But a falling stock market price would not be the primary indicator in such a situation, nor would a rising one signal you have done well.

Margin of Safety, the central concept of investment

The intellectual principle of the margin of safety involves “inverting” a stock and thinking about it like a bond.

The margin of safety for bonds may be calculated, alternatively, by comparing the total value of the enterprise with the amount of debt

For example, if a business owes $X, but is valued at $3X, the business could shrink by 2/3rds before imperiling the position of the debt holders.

Similarly,

when a company has outstanding only common stock that under depression conditions is selling for less than the amount of bonds that could safely be issued against its property and earning power

the common stock can be considered to enjoy a margin of safety as large as that of a good bond.

Broadly, margin of safety can be thought of as the consistent earnings power of the equity, wherein

the margin of safety lies in an expected earning power considerably above the going rate for bonds

A proxy measure here would be to look at the earnings rate, or earnings yield (earnings/price) and compare this to the going rate on a similar bond.

Another, more general way to think about Margin of Safety is that it is the difference between how much you pay for something versus the calculated intrinsic value you determine that thing to have. In this sense, the Margin of Safety is always price dependent and will be higher at lower prices and lower at higher prices, relatively speaking.

And the Margin of Safety works in tandem with the principle of diversification:

Even with a margin in the investor’s favor, an individual security may work out badly. For the margin guarantees only that he has a better chance for a profit than for a loss– not that loss is impossible. But as the number of such commitments is increased the more certain does it become that the aggregate of the profits will exceed the aggregate of the losses. That is the simple basis of the insurance-underwriting business

The emphasis is always on finding an adequate margin of safety in order to protect your principal because if you do that, the returns will tend to take care of themselves:

To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.

Special note on market-timing

There isn’t much more to it than this:

if he places his emphasis on timing, in the sense of forecasting, [the investor] will end up as a speculator and with a speculator’s financial results

In case you’re wondering, that’s a bad thing in Graham’s mind because he is convinced that all but the most talented and luckiest speculators lose out in the end because they do not pay attention to safety of principal.