There is a powerful phrase that shapes the thinking of top venture capitalists. The way of thinking captured in this phrase is helpful for stock investors, too. As a mindset, it helps tame the uncertainties and risks that are a constant reality of investing.
First, let’s consider some background. The successful venture capitalist (VC) has two big puzzles to solve. At first glance, the puzzles seem to contradict each other.
- On the one hand, a VC needs to be open to wild possibilities, including startup ideas that seem crazy at first. It is far more costly, in the long run, to turn down a grand slam investment than to incur a small investment loss.
- On the other hand, a VC needs a means of filtering ideas and saying “no.” For every pitch that gets funded, there will be hundreds that have to be turned down. This requires a point of view about the world.
That balance between open-mindedness and conviction requires extraordinary flexibility. The future is hard to predict, and in most cases impossible to predict, which makes it very hard (and again sometimes impossible) to spot big winners in advance.
Take Google as an example. With hindsight, funding Google seems like a no-brainer; it is one of the most dominant and profitable companies in the history of the world.
But Marc Andreessen, a prominent billionaire VC and co-creator of the Netscape web browser, points out why a number of smart VCs turned Google down when the founders first sought funding.
When Google was born, it wasn’t the first search engine startup, or even the fifth one or the tenth. It was the thirty-fifth. Web search was seen as a terrible business at the time; rather than a way to make money, it was a kind of loss-leader to draw traffic to portals.
Even worse, all of the search engines that had come before Google were lousy — it seemed junky results were just an inherent reality of the world wide web — and no search business had a logical way of making money. (Neither did Google for its first few years.) And yet, funding Google could have put you in the VC hall of fame.
Airbnb was another idea that seemed too crazy to invest in. When the Airbnb founders sought funding in 2009, they were literally laughed at by some of the investors they pitched.
Even the VCs who gave Airbnb money had to fight their skepticism instincts because the idea seemed so bizarre (connecting strangers on the internet, so that one stranger could sleep in another stranger’s house). Today, Airbnb is a profitable juggernaut valued at more than $30 billion.
Doug Leone, a billionaire partner at VC firm Sequoia Capital, says “The biggest outcomes come when you break your previous mental model.”
The more unexpected or unconventional the startup idea, the more potential power it has — because it’s the strange or wild ideas that represent a paradigm shift from the way things worked before. This in turn offers the best chance to create tens of billions or even hundreds of billions in value.
But at the same time, you can’t just go around funding everything. There isn’t enough venture capital money in the world for that. Competent VC firms also tend to develop expertise around specific areas, like biotech or consumer retail or aerospace.
The need for layers of domain knowledge — to properly evaluate the startups being considered — also restricts what it makes sense for a VC to focus on. The “universe of investable ideas” has to be narrowed down to something manageable. The net result is that, no matter how open-minded they are, VC needs opinions and a point of view.
The phrase that Marc Andreessen and other VCs use to create this mindset, in which open-mindedness and conviction find a flexible balance, is “Strong Opinions, Weakly Held.”
“Strong Opinions, Weakly Held,” or SOWH for short, was coined by technology futurist and Stanford University professor Paul Saffo in the 1980s.
Saffo describes SOWH as a way to create useful forecasts as to what the future may hold, while remaining flexible and maintaining the ability to change. Saffo describes the process like this:
“Allow your intuition to guide you to a conclusion, no matter how imperfect — this is the “strong opinion” part. Then — and this is the “weakly held” part — prove yourself wrong. Engage in creative doubt. Look for information that doesn’t fit, or indicators that are pointing in an entirely different direction. Eventually your intuition will kick in and a new hypothesis will emerge out of the rubble, ready to be ruthlessly torn apart once again. You will be surprised by how quickly the sequence of faulty forecasts will deliver you to a useful result.”
The SOWH mindset helps VCs develop strong opinions — a necessary element when investing large sums — but also to pivot when new data comes in.
Doug Leone of Sequoia also says it is helpful for VCs to have “Dumbo Ears,” in order to detect the weak signals that hint at rising forces of change.
Because this new era is dominated by change, the value of the SOWH mindset is rising for investors, too. It used to be a straightforward process to figure out which companies and industries were “safe” (i.e. future proof) and which were not — but as the Kraft-Heinz debacle showed, that is no longer the case.
Investors also have the challenge of choosing from a huge smorgasbord of opportunities. There are thousands of investable stocks in the United States alone, and thousands more if you go international.
Even if an investor chooses to only invest in exchange-traded funds (ETFs) or professionally managed mutual funds, there are hundreds of choices and dozens of themes and weightings to choose from.
The SOWH mindset is helpful for another reason, too: The natural tendency is to go the opposite way.
Instead of “Strong Opinions, Weakly Held,” we are naturally wired to embrace “Weak Opinions, Strongly Held” by default.
It is a function of the human condition — for all humans, not just investors — to be overly protective of our own ideas and beliefs, even when this isn’t rational, and to be defensive when our ideas are challenged.
Andreessen has a theory that people tend to treat their ideas like children. He came to this view after doing mountains of psychological research in an effort to root out unhelpful tendencies within himself.
In Andreessen’s view, the human brain subconsciously treats ideas like offspring as a kind of default setting. If the idea is your own, and you are proud of it or personally identify with it, then the idea is something to nurture and protect and defend (like one of your kids).
The SOWH mindset goes directly against this — it encourages the ability to not get too attached to ideas, and a readiness to let those ideas go. This is important in the process of investing. Even the best investors in the world make mistakes — on a regular basis, in fact — and have to “let go” when they do.
As with so many other areas of investing, well-designed software can make the process easier.
By learning to invest in a systematic way, with the help of rules and software, you can adopt the SOWH mindset subconsciously over time, with the software making it easy to stay disciplined.
- If the SSI is green, price and volatility indicate a healthy state.
- If the SSI is yellow, it warrants caution or a period of transition.
- And if the SSI is red, that is the warning sign of an unhealthy state.
We can use the SSI, and other simple tools, to develop a logical set of rules around when and where to invest. The SSI overlay guides us on when to have a “strong opinion” — if the SSI is green, we are good to go — and when we should consider changing our minds based on data.
It is possible to develop a sophisticated template with these rules that cover a wide variety of situations.
For example, sometimes an early investment idea can be in the red zone, in which case we can keep an eye on it, but wait for entry until the SSI improves. Or if a name we like fundamentally goes from green to red, we can pause our involvement and wait to rebuild a position, and so on.
The result is that, through the use of software designed to shape our behavior and help make smart investment decisions, “Strong Opinions, Weakly Held” can be something more than a phrase we struggle to apply with willpower alone. We can deploy SOWH systematically through a combination of rules and software and make it a subconscious part of our natural investment life.
Richard Smith, Ph.D.
CEO & Founder, TradeSmith