Second-Order Thinking: What Smart People Use to Outperform

“Experience is what you got when you didn’t get what you wanted.”

— Howard Marks

Sometimes when we tackle one problem, we end up creating worse ones.

Consider a country that, wanting to inspire regime change in another country, funds and provides weapons to a group of “moderate rebels.” Only it turns out that those moderate rebels will become powerful and then go to war with the sponsoring country for decades. Whoops.

The ability to think through problems to the second, third, and nth order—or what we will call second-order thinking for short—is a powerful tool that great thinkers use to their advantage all the time.

 

Second Order Thinking Example

Second-Order Thinking

In his exceptional book, The Most Important Thing, Howard Marks explains the concept of second-order thinking, which he calls second-level thinking.

First-level thinking is simplistic and superficial, and just about everyone can do it (a bad sign for anything involving an attempt at superiority). All the first-level thinker needs is an opinion about the future, as in “The outlook for the company is favorable, meaning the stock will go up.” Second-level thinking is deep, complex and convoluted.

Second-order thinkers take into account a lot of what we put into our decision journals. Things like 1) what are the key variables and how do they interact?, 2) where is the leverage?, and 3) if I take this action, what happens next?

First-order thinkers look for things that are simple, easy, and defendable. They fail to realize that they are dealing with complex systems, or if they do realize it, they mistake cause-and-effect relationships. They are incapable of thinking in terms of second and subsequent steps. And, more fundamentally, they are generally unaware of the need to think in terms of second steps.

Second-order thinkers, on the other hand, think in terms of interactions, time, and system dynamics. They are aware of iatrogenics and our bias toward intervention.

“It’s not supposed to be easy. Anyone who finds it easy is stupid.”

— Charlie Munger

First-level thinkers all look alike. They think the same way other first-level thinkers do, and they usually reach the same conclusions. This is where things get interesting. Extraordinary performance comes from being different. It must be that way. Of course, below-average performance comes from being different, too—on the downside. But the road to out-thinking people can't come from first-order thinking. It must come from second-order thinking.

The Necessity of Smart Divergence

“The problem is that extraordinary performance comes only from correct nonconsensual forecasts, but nonconsensual forecasts are hard to make, hard to make correctly and hard to act on,” Marks writes.

You can’t do the same things that other people are doing and expect to outperform them. When you do what everyone else does, you're going to get the same results everyone else gets. But it's not enough to be different — you also need to be correct.

The goal is not blind divergence from the crowd but rather a way of thinking that sets you apart from others. A way of thinking that gives you an advantage.

We can look at this issue as a simple two-by-two matrix (via The Most Important Thing):

Second Level Thinking Matrix

I’m generalizing a bit here, but if your thoughts and behavior are conventional, you’re likely to get conventional results. Steve Jobs was right.

Many people are simply unwilling to be wrong because that means they might look foolish. Yet this is a grave mistake.

“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

— John Meynard Keynes

The ability to risk looking like an idiot, at least in the short term, is necessary for being different. If you look like everyone else, you never look like a fool. Of course, you also never outperform everyone else.

Second order thinking graph

Second-order thinking takes a lot of work. It's not easy to think in terms of systems, interactions, and time. However, doing so is a smart way to separate yourself from the masses.

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If you want to have fun at work this week, do one of two things. First, start digging below the surface of people’s opinions. Ask people why they think what they think. Second, ask them to take the other side of the argument.