Unwarranted and Unfounded Assumptions Bus Driver Riddle
Kennon-Green & Co. Global Asset Management, Wealth Management, Investment Advisory, and Value Investing

Many of the Problems In Your Life Are Due to Your Assumptions

One of the biggest secrets to success in life and business is to always check your assumptions.  Whether you realize it or not, you are full of assumptions.  You walk around every day, all day, making assumptions about people, places, political parties, institutions, companies, books, music, and consumer products.  By identifying these assumptions you can examine whether or not they are rational and reasonable.

To illustrate my point, consider the following riddle:

A bus driver was heading down a street in Colorado. He went right past a stop sign without stopping, he turned left where there was a “no left turn” sign and he went the wrong way on a one-way street. Then he went on the left side of the road past a cop car. Still – he didn’t break any traffic laws. Why not?

How is that possible?

The answer is surprisingly simple: The bus driver is walking.  The riddle simply stated his occupation and did not in any way indicate that he was in a motor vehicle.  Yet, in an attempt to quickly calculate an answer, most people are likely to assume that the bus driver is driving a bus.  That assumption is unwarranted.

When you begin to extricate your assumptions and examine them, you realize how they jade your view of the world.  This includes business and investing.

Checking Your Assumptions In Your Investments

Check Your Unwarranted and Unfounded Assumptions in Your Investments

The market price of every investment has assumptions built into it. Your job is to examine these assumptions and determine if you believe they are unwarranted or unfounded.

If you buy shares of a company at 25x earnings, or a 4% earnings yield, and you believe you are going to earn 10.5% on your investment, you are implicitly assuming that profits are going to grow at 10%+ compounded for at least a decade (or 25% for 5 years, or 50% for 2.4 years … there are a lot of ways to get there).  After all, that is what it would take to turn a 4% earnings yield into a nearly 10.5% earnings yield.  For a mature blue chip dividend paying company, that is a significant assumption.

One of the first things I do when I consider investing in a stock is look at the current market price and ask myself, “What is the market assuming future earnings growth is going to be if I want to hit a [insert discount rate here] rate of return?”  Then I decide whether or not I think that is reasonable based upon my interpretation of the 10K, annual report, and other data.

Assumptions Extend to Your World View, Society, Religion, and Political Beliefs

Assumptions are not limited to business.  They can influence everything you do if you aren’t careful.

Nearly a decade ago, I was sitting in an undergraduate arts management course at college.  The professor, a very nice woman whom both Aaron and I like a great deal, made a point.  She asked, “How many of you support parental notification laws for minors that want an abortion?”

[mainbodyad]I, along with many other students in the class, raised my hand.  My belief was that if a parent can be sued for the conduct of a child, is financially responsible for a child, and has to deal with the risk management of the child, they should have the right to be informed of major medical decisions of said child.

Then, this professor began to ask us questions using the socratic method.  She never forced her beliefs on us, she simply asked: “Why do you believe some people oppose parental notification laws when it comes to abortion?”

To be honest, I was stumped.  I couldn’t come up with a rock-solid reason, I just simply took it for granted that a significant portion of the left-wing in the United States thought parental notification laws were wrong.

Then, the professor asked those of us who supported parental notification laws about our background and personal lives.  It wasn’t a coincidence that each of us came from well-off, stable households with parents that were still married, still played an active role in our lives, and with whom we were still close.

Almost instantly, it became clear that we had made two enormous assumptions that were responsible for our support for parental notification laws:

  • Assumption #1: All families were like ours – only then, with horror, did we realize that the reason many parental notification laws were opposed in the deep south involved cases of rape and incest.  A blanket parental notification law would require a teacher or rape counselor to notify the very father that had raped and impregnated a girl.  Alternatively, imagine a young 13 year old girl is raped and impregnated by a sex offender.  If she comes from an incredibly religious family, they might force her to withdrawal from school and then raise the child conceived from the rape.
  • Assumption #2: Girls that get themselves into the situation of needing to avoid parental notification were promiscuous, immoral, irresponsible, and stupid.  Again, the idea of rape, incest, or abusive parents didn’t even occur to any of us who came from stable, loving families because of our first assumption.

By identifying those assumptions, we could better make a fully informed decision.  It would be rational to continue supporting parental notification if you believe that these cases are such a tiny minority that the damage done trying to correct them would grossly exceed the alternative.  But it is also rational to continue being pro-life and opposing parental notification laws once you realize that not all families are loving, supportive, and close-knit.

Emotional Trauma Is Often Caused By Frustrated Assumptions and Expectations

A few years ago, an acquaintance of mine was discussing a theory from her field that “trauma was anything that interrupted or frustrated your expectations”.  Expectations are based upon assumptions.

Think about it.  When fights occur that ruin lives, friendships, and families, they occur because an expectation based upon an assumption is shattered:

  • A child decides not to go to college and instead become a painter.  The parents go crazy because they assumed their child would graduate with a degree.
  • An older parent sells their house, investments, and worldly goods, using all of his or her money to travel the world and live it up before death.  The adult children grow frustrated and angry because they assumed they would be getting an inheritance.
  • A Christian parent becomes depressed because their child converts to Buddhism because the parent assumed their child would have the same religion.
  • Parents disown their children upon learning they are gay or lesbian because they assumed their son or daughter were straight.  They have probably had this assumption since birth, often picturing their kid getting married to an opposite-sex spouse.
  • A child comes home with a boyfriend or girlfriend of a different race.  Although this is much less of an issue today, the emotional trauma to parents a few generations ago was based upon the assumption that the child would marry within their own race.
  • A daughter has a child out of wedlock.  The parents become ashamed because they assumed their daughter would be married before giving birth and because they assume that other people assume their daughter is a “whore”, which is probably not true (and a standard certainly not extended to the man involved, who bears equal culpability!)
  • You face a painful divorce, which feels like a failure or even a death.  You assumed your marriage would last for a lifetime.
  • You get great reviews at work, the boss praises you constantly, yet you lose a promotion to a less qualified coworker.  You assumed you were going to get the job, making the loss more painful than if you hadn’t thought there was a chance for you to get it.
  • You assume that a more expensive item is better than a cheaper alternative, which is not necessarily true.
  • You assume that a teenager in baggy clothes is more likely to steal from your store than a mom with kids though the latter is actually more likely to shoplift.

These are just a few examples of how we take assumptions for granted.  You can greatly increase your personal happiness by going through life and periodically asking, “What are my underlying assumptions?”  Then examine them and determine if those assumptions are warranted or unfounded.