Second Order Thinking

by

Want To Make Higher Quality Decisions? Here Are Famed Investor and Oaktree Capital Co-Founder Howard Marks’s 5 Rules For Better Decision Making

Howard Marks has a process for making better investment decisions. He uses the mental model: Second Order Thinking.

This mental model provides a great toolset for thinking through a decision more thoroughly, and understanding longer term consequences.

It allows you to seem like you’re seeing into the future.

Let’s dive in.

Rule #1: First Order Thinking is superficial

First Order Thinking is knowing the immediate cause-and effect of ones actions.

It is understanding the immediate-term consequences of something.

Everyone does this. It’s a pretty easy way to go about decision-making.

But if everyone does this, no one separates themselves from the pack—everyone’s quality of decision making is the same.

The Most Important Thing, by Howard Marks, Co-Founder of Oaktree Capital

Rule #2: Second Order Thinking is hard, but worth it

Second Order Thinking involves considering what happens after the effects of ones actions or decisions.

It’s thinking about the consequences of the consequences. The effects of the effects.

Warren Buffet provides a great and simple example of Second Order Thinking, courtesy of The Great Mental Models, Vol 1:

  • Imagine standing in a crowd at a parade. You have a hard time seeing the parade from behind the crowd.
  • You decide to stand on your tip toes to see better.
  • More and more people follow suit so they can see better.
  • Soon, everyone is standing on their tip toes.
  • Now, no one can see any better, but everyone is worse off.

First Order thinking would be deciding to stand on your tip toes in order to see.

Second Order (or even Third+ Order thinking) would be considering that if you stand on your tip toes everyone will, no one will see any better, but now everyones toes hurt.

This level of thinking is naturally a lot harder to do—it requires more brainpower and more deep thinking on a problem.

However, taking the extra time to think further ahead will translate to much higher-quality decisions.

And since fewer people think in Second or Third-order consequences, you’re making better decisions than most.

Principles by Ray Dalio, Founder of Bridgewater Associates. Quote courtesy of Coffee and Junk

Rule #3: Ask The following questions to think in Second Order

There are some easy-to-remember techniques for Second Order Thinking. Farnam Street Blog suggests:

  • Always ask yourself: “And then what?”
  • Ask yourself: “What do the consequences look like x days, weeks or years from now?”
  • Write down the consequences of the consequences—which are positive vs negative? This will help give you a better accounting of which decision has the best long term result.

Rule #4: Long term gains are usually better than short term gains

By leveraging Second Order Thinking, you are thinking further ahead.

You’re considering impacts days, weeks or even years from now.

You’ll often find decisions having the best outcomes means improved long term gains, at the cost of shorter term pains.

Thinking in second-order consequences will help you to better consider when you should prioritize the short term vs the long term, and know which are the better yields.

Rule #5: Beware of analysis paralysis

Second Order Thinking will yield more quality decision making, but be careful not to go too crazy with it.

If you think of all possible effects of something, you might end up never acting and constantly analyzing.

Instead, consider all the likely effects of something.

Avoid the tendency over-analyze, and be mindful of the right balance of analysis vs action.