Wharton Alumni March: Marines to FinTech

Editor’s note: Patrick R. Cleary W03, chief operating officer and managing member of Alpha Architect, co-wrote this piece.

Read more about how Pat and Wes met at Wharton, then teamed back up together to launch their finance technology (FinTech) startup, in our recent “Wharton Effect” profile.

Wharton alumni have served in the Marines. What do they take with them to the world of finance?

Photo credit: Wikimedia Commons

Serving in the Marine Corps was an unforgettable experience. Civilians often tell us, “Thank you for your service”; however, the real “thanks” are due to the Corps for giving us valuable life lessons. The not-so subtle teachings bestowed upon us by heavily muscled, insanely aggressive Marine Corps Drill Sergeants are still, literally, ringing in our ears: “Listen here, pond scum, you better run faster, shoot straighter and decide quicker if you are going to win in battle!” Years later, we would test that theory in real-time, battling insurgents in Iraq.

Thankfully, the lessons learned in the military kept us alive and brought us home. Today, we continually discover that the “combat classroom” proves to be the best preparation for a deployment to Wall Street. They guide all of our business and investment decisions at our emerging asset management firm, Alpha Architect.

The four biggest lessons learned are as follows:

  1. Humans Are Emotional: Losing money is an emotional event; getting shot at is even more emotional. A systematic approach for handling chaotic environments is critical to success.
  2. Rambo isn’t Realistic: Pumping iron and strapping hundreds of rounds across our chest might work in the movies, but in real-life, evidence-based approaches to warfare are much more effective.
  3. Complacency Kills: Success is often the surest way to predict defeat. Victory leads to overconfidence, overconfidence leads to laziness, and laziness can lead to death.
  4. Integrity is Everything: If you can’t trust the man to your left and your right, you cannot accomplish the mission. Honest communication and full transparency are paramount to any endeavor.

LESSON 1: Humans Are Emotional; Systems Beat Behavioral Bias

While stationed in Iraq, we saw stunning displays of poor decision-making. Obviously, in areas where violence could break out at any moment, it was of paramount importance to stay focused on standard operating procedures. But in extreme conditions where temperatures regularly reached over 125 degrees, stressed and sleep-deprived humans can sometimes do irrational things.

For example, carrying 80 pounds of gear in the frying desert sun makes you hot. But many things that are necessary for survival in a combat environment, such as extra water, ammunition and protective gear, are heavy. A completely rational thinker weighs the cost of carrying gear (sweating profusely, uncomfortable and so forth) against the benefits (not dying). A more emotionally driven decision-maker disregards a cost-benefit analysis and goes with his natural instinct—toss all the gear, get some fresh air and hope for the best.

An example of a rational approach to combat and an irrational approach to combat are highlighted in the picture below. Wes is situated at a combat checkpoint in Haditha, a village in Al Anbar Province. He is explaining to his Iraqi counterparts how to set up a tactical checkpoint. A quick inspection of the photograph highlights how a stressful environment can make some people do irrational things. Wes and his Iraqi friend in the photo are wearing Kevlar helmets (important because mortar rounds are inbound), carrying extra ammunition (important because one needs ammunition in a gunfight when terrorists are slinging hundreds of 7.62mm rounds in one’s direction) and have a water source on their gear (important because in 125 degree weather a lack of hydration can lead to heat stroke).

And while all of these things sound rational, the Iraqi on the right isn’t wearing a Kevlar, isn’t carrying extra ammo and doesn’t have a source of water.

Wharton alumni Wes Gray in Iraq

Chaotic environments + emotion + sress = bad decision-making. Photo credit: Alpha Architect.

Is Wes’ irrational Iraqi friend abnormal? Not really. All human beings suffer from behavioral bias and these biases are magnified in stressful situations. After all, we’re only human.

The Wharton Alumni’s Financial Translation:

The conditions we describe in Iraq are analogous to conditions investors find in the markets. Watching our hard-earned wealth fluctuate in value is stressful. Stressful situations breed bad decisions. To avoid the potential for bad decisions in stressful environments, we need to deploy systematic decision-making.

The Marine Corps solution bad-decision making involves a plethora of checklists and standard operating procedures. To ensure these processes are followed, the Corps is religious about repetitive training. The Marines want to “de-program” our gut instincts and re-program each Marine to “follow the model.” And while this might sound a bit Orwellian, automated reactions in chaos give us the best chance of survival. In combat, something as simple as a dead battery in a radio or a forgotten map can be the difference between life and death. To make good decisions in stressful situations, Marines follow a rigorous model that has been systematically developed and combat proven. The lesson is clear: In order for decision-making to be effective, it must be systematic.

LESSON 2: Rambo Isn’t Realistic; Act Based on Evidence, Not on Stories

For many civilians, their only “experience” of war is from video games and Hollywood movies. A classic example is the Rambo movies series. Rambo is a 1980s action movie series starring Sylvester Stallone as a deranged Vietnam War Special Forces veteran hell-bent on blowing things up and killing anyone who gets in his way. Rambo has a remarkable ability to kill waves of foreign soldiers furiously shooting in any direction. For example, in Rambo III, Rambo kills 132 enemies and is involved in 38 episodes where he manages to avoid getting killed by enemy gunfire.

 

Watch the official trailer for Rambo: First Blood Part 2 (1985) for a better appreciation of the classic 1980s warrior.

 

Being Rambo sounds cool in theory, but doesn’t work in practice. Marines, take a different, more evidence-based approach. Marines ensure all ammunition is loaded into clean-functioning magazines that are stored on their person. They also spend countless hours loading and unloading magazines into their rifles to ensure the process is seamless in a combat environment. Finally, Marines take well-aimed shots at their enemy, focusing on the principles of marksmanship, even when they are amped up and in the middle of a firefight. A single effective round is worth 30 poorly aimed shots.

Rambo is a story and Rambo’s actions are not based on evidence. And yet, everyone wants to believe there is a heavily muscled superstar warrior who is invincible.

But why do we believe in these stories? The foundation for our persistent belief in stories, in spite of evidence suggesting a story is literally unbelievable, has perplexed researchers for many years. In one classic academic study, the behavioral psychologist B.F. Skinner and several colleagues demonstrated that our innate need for superstition is deeply ingrained in our primal brains. To make the point, Skinner studied one of the more powerful brains in the animal kingdom—the pigeon.

Skinner put hungry pigeons in a cage and dispensed food pellets to them every five seconds. Now, pigeons will naturally wander around any space looking for food and will do so in predictably pigeon-like ways. One pigeon might step to the left and then step to the right; another pigeon might jump, land and then jump again. Every five seconds, researchers released a food pellet. Quickly, the pigeons began to associate their random movements with the magically appearing food. After a few rounds of engaging in the same random activities and earning a series of food pellets, the pigeons developed an internal belief that one of their deliberate actions in the cage was actually causing food pellets to pop out of the feeder.

Amazingly, once a pigeon establishes its pellet dispensing ritual, it is exceedingly difficult to train the pigeon out of that particular “story.” Skinner attempted to give the pigeons evidence that their story was worthless (e.g., dispensing pellets at random times), but the pigeons continued with their story-based ways. Evidence has a hard time entering the decision-making process once a behavior has been established.

The Wharton Alumni’s Financial Translation:

Do we see Rambo activity in financial markets where people believe a story, but disregard evidence? All the time. Take Wes’ uncle as an example. He is convinced that a Dallas Cowboys victory during the Thanksgiving Day football game is a great signal for the stock market. The logic is as follows: The Cowboys are “America’s Team,” and if America’s Team is doing well, people are happier and they spend more money.

Of course, the “Dallas Cowboys” indicator is completely bogus. But there are many other stock market superstitions—sell in May and go away; let your winners run, but cut your losses; head and shoulders patterns; this is a stock-pickers’ market; invest in what you know; buy with a margin of safety; and so forth. Some of these stories are backed by evidence, others are not. The main point is that one’s investment process—or weapons handling process—should not be based on a story but rather on an evidence-based process that demonstrates robustness over time.

LESSON 3: Complacency Kills; Focus on Fundamentals

During Operation Iraqi Freedom, the message was everywhere. In the chow hall, on blast walls, in supply bays, and at checkpoints. “COMPLACENCY KILLS” was spray painted in bold, black, stencil letters. Below is a picture Wes took in Barwana before heading out on a combat patrol. The reminder was seen by all Marines going on a patrol “outside the wire.” The large mortar shell damage above the “Complacency Kills” writing was a strong reminder of why this message was important.

Wharton Alumni Patrick Cleary in Iraq

Looking cool doesn’t make you combat effective. Photo credit: Alpha Architect.

The greatest enemy in a combat situation is not necessarily the enemy on the other side of the fence—it is ourselves!  Keeping your weapon clean, your vehicle maintained, or your body awake, could be a life and death decision. And these were conscious decisions made every day. Fighting complacency is difficult. It requires discipline, patience and relentless attention to detail. The fundamentals are boring, but they are often the most important.

The Wharton Alumni’s Financial Translation:

Perhaps not surprisingly, complacency also kills in the financial world. When meeting with investors or family offices, we often see signs of complacency and a disregard for investing fundamentals. For example, investors sometimes do not focus on fees and spend too much money on their investment adviser or end up buried in expensive bank products they don’t understand.

Investors also lose sight of the importance of taxes. Failing to stay vigilant to the effects of portfolio turnover or on the choice of investment vehicle can destroy returns. What is the real value of alpha for a taxable investor in a fund that earns a 10 percent return, but only 5 percent after tax? Perhaps a more tax-efficient fund, with lower turnover, makes the most sense?

Another area where we see investor complacency is in allocations. Over time, allocations can get out of whack, as investors fail to maintain target allocations or struggle to stay vigilant to portfolio rebalancing requirements. Investors can become overly concentrated in positions or asset classes (such as being over allocated to cash). Also, in low-volatility environments, investors can be lured by the siren song of leverage. Nevertheless, as investors, it is important that we make consistently good decisions in order to make a return on our capital while not taking unnecessary risks.

We need to always focus on the fundamentals and avoid complacency. In the Marine Corps, the fundamentals are simple: Shoot, move, communicate. In investing, the fundamentals are also simple: maximize after-tax, after-fee, risk-adjusted returns. But just because something is simple, doesn’t necessarily mean it is easy. We need to religiously focus on the fundamentals. Remember: COMPLACENCY KILLS!

LESSON 4: Integrity is Everything; Do Things Right and Do the Right Things

Of the 14 Marine Corps leadership traits, integrity is probably the most important. The official definition is the following: “Uprightness of character and soundness of moral principles. The quality of truthfulness and honesty.” To both of us, having integrity means doing things right and doing the right thing.

Integrity can literally save lives, as Pat experienced.

An increasingly important part of Pat’s mission in Fallujah was to build fortified positions along key pieces of terrain. Such positions prevented bomb-makers from “planting” their products, but of course, Marines can’t watch everything and every additional Marine sitting in a defensive position brings its own risk. You have to be brutally honest with yourself in terms of risk (Marines lost) versus reward (bad guys thwarted and/or killed).

Of course, in the “Fog of War” that honesty can be tough to preserve. A particular company officer, rightfully seeking to minimize bomb casualties as much as possible, requested that an oversight position that sat atop a highway overpass. While the position provided great visibility, you could also drive a suicide car bomb, literally, underneath the post. It simply didn’t make sense to take on that amount of risk, based on the evidence from prior experiences.

What started as a simple disagreement between officers quickly escalated into an expletive laden diatribe as to why Pat, as a junior Lieutenant, should “shut the hell up and build the post.”

Pat knew it was a bad idea and wasn’t the right thing to do. Building that post was nothing more than a star-spangled piñata for any terrorist to strike and Marines would needlessly die if constructed. Pat stood his ground, took the verbal beating and built a post that he thought could withstand a potential attack. Throughout the entire episode, he was, in the back of his mind, running the odds of when, and how, he would be relieved of command for insubordination.

But that word never came. In fact, terrorists hit the post the day after it was built. The post took the blast and the overpass itself was completely destroyed.

“Thank God we didn’t build it that way,” Pat muttered. “Corpsman! [Marine-speak for medic]. How many casualties did we take?” Pat dreaded the potential answer, but he had to know. It was his unit’s work and ultimately his call.

Pat’s Marines responded, “We’re good sir. No KIAs. Boys definitely got their bells rung, but they’ll be alright.”

It wasn’t easy for Pat to maintain his integrity, but his Marines are certainly glad he did. Doing things right and doing the right thing literally saved Marines’ lives.

The Wharton Alumni’s Financial Translation:

In the context of finance, integrity doesn’t necessarily determine the difference between life and death, but it does have the same level of importance. Warren Buffett has said that integrity is everything: “In looking for people to hire, you look for three qualities: integrity, intelligence and energy. And if they don’t have the first, the other two will kill you.”

It is hard to disagree with Buffett or our experience in the Marines. Investors work extremely hard to earn their wealth and they are putting their families future on the line when they hire an investment advisor or asset manager. A broker may be encouraged to sell a specific product that isn’t necessarily good for his client, but the broker thinks to himself, “Aw, no big deal. Nobody will ever know, and I need to get paid.”

But it is a big deal. This is a breach of integrity and the broker isn’t doing the right thing. The client becomes worse off and the broker gets rich.

Successful counterinsurgency campaigns are measured in decades. The foundation for a lasting peace requires years of listening, respecting, building and empowering a local population to achieve their vision of a society. There are no shortcuts. There are no easy answers. The motto in the Marine Corps was as follows: “No better friend, no worse enemy.” From general to private, Marines are expected to govern themselves with the highest standards and the purest of intentions day in and day out. Despite all of the new technology, tactics and cutting-edge gear, survival remains a struggle of willpower (destroying the enemy’s, while simultaneously controlling and channeling our own).

Most shortcuts in finance are ill-conceived at their best and outright illegal at their worst. History is replete with examples of those who pursue shortcuts in this business and those who keep it simple, follow their model and stick to the plan (Buffett and Vanguard’s Bogle are personal favorites). Like most things in life, things worth doing take hard work, persistence and a clear plan.

We hope that our look back on the lessons learned in the Marine Corps informs how we carry ourselves and our business. We are thankful to have served with such courageous men and women that tried to make a small corner of the world a better place. The world of finance will always change, but the lessons learned in the military will serve us for years to come. Semper Fidelis.

Editor’s note: The original version of this article first appeared on AlphaArchitect.com on May 25, 2015.

 

 

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