What is second-level thinking?

In his book, The Most Important Thing, Howard Marks explains it:

Whereas first-level thinking is simplistic and superficial, and everyone can do it, second-level thinking is deep, complex, and convoluted.

Search Youtube for Howard Marks-Second Level Thinking. It’s a great 2-minute video.

Second-level thinking means checking much of what you already know about a subject (e.g. investing) at the door. Like Adam Grant recommends in his book Think Again, you must first unlearn and then, relearn.

How does this help the individual investor?

Here’s one example:

As a first-level thinking index investor, I once believed as fact that markets are efficient. Entire books are written about it (e.g. A Random Walk Down Wall Street, by Burton Malkiel). But when markets crashed in March 2020, how could that be efficient? It doesn’t make sense.

Second-level thinkers would dive deeper to learn more. Perhaps, markets are mostly efficient, but with periods of extreme volatility. It’s a more complicated and nuanced portrayal of markets. This must be understood, though, to become a better investor.

And another example:

In 2023, these investing “rules of thumb” are everywhere:

• “Buy the dip!”
• “Dollar-cost average!”
• “Target date funds are easy!”

But, consider a different time. Imagine that you joined the workforce in 1943. You invested your lifetime savings in the Dow Jones Industrial Average (the Dow) companies. What a great idea, and so ahead of its time! This was the buy & hold passive index “fund” of its day!

Did you know that your investment return over the next 40 years -your entire working career- would be 1%? Not 1% compounded annually…1% over the entire 40 years.

• Dow in June 1943 - 2,451
• Dow in July 1982 - 2,480

Thank goodness for pensions.

Imagine your 60-year-old self in 1982. You started work at 20 years old in 1943. You earned 1% in the stock market over your entire 40-year career.

What were the investing “rules of thumb” then?

Probably something similar to “do NOT invest in the stock market!” Or more specifically:

• “Do not buy the dip”
• “Do not dollar-cost average into a no-growth investment”
• “I don’t know what a target date fund is?! But if it has to do with stocks, I don’t want one!”

The crazy thing? Using 1982 conventional wisdom, you would have missed out on 40 years of incredible gains in U.S. stocks.

You can read more in my post Why I don’t like target date funds (and other unconventional wisdom).

Second-level thinking is hard. And it takes time. But it makes you better. It gives you an edge.

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