The Curse of Category

A student says, “Master, please hand me the knife,” and he hands the student the knife, blade first. “Please give me the other end,” the student says. And the master replies, “What would you do with the other end?”

― Alan W. Watts, “What Is Zen?” (2000)

We have a blueberry bush right outside our porch. It hasn’t had a great year, and here in the middle of September we are way past blueberry season in Connecticut. I know that. I’m from the South, so I’m familiar with pokeweed, which also has purple berries, but a cluster of pokeberries looks nothing like a cluster of blueberries. I know that. Pokeberries are poisonous. I know that, too.

So why did I eat one this morning?

I made a category error.

Bizarrely, we have a pokeweed plant growing exactly within the blueberry bush. I’ve been traveling a lot (so I haven’t paid any attention to the blueberry bush), I didn’t sleep great (so I was groggy), and I was thinking about my next ET note (so I was distracted). I saw a purple berry with the same shape as a blueberry in exactly the same place where I’ve grabbed blueberries before.

In that moment, I was literally Homer Simpson. Mmmmm … blueberries.

Now I only ate one, and pokeberries are only truly problematic if you eat a handful and you have the body mass of a small child or a dog. My body mass is … umm … some multiple of a small child’s, so I was fine. A bit of, shall we say, intestinal distress, but all short-lived and none the worse for wear and tear.

What’s a category error? It’s calling something by the wrong name. It can be a Type 1 category error, also called a false positive, which is what I did. I said, yum, here’s a blueberry, but it was really a pokeberry. There are also Type 2 category errors, also called false negatives, which would have been the case if these had truly been blueberries but I had said, nah, they’re pokeberries, and passed them by.

Now both Type 1 and Type 2 errors are problematic in life and in investing. In fact, Rusty just published a really good (and really fun) note about Type 1 and Type 2 errors, titled Roadkill. It’s well worth your time. For an older note I wrote about category errors in general, check out Ghost in the Machine. It’s well worth your time, too.

For this In Brief note, though, I just want to make two quick points about category errors. In my experience …

It’s the Type 1 errors that are most likely to kill you. Both in life and in investing. It’s when you’re oh-so sure that you’re chomping down on a really great trade … that’s when you blow up. Or get poisoned.

We’re most likely to make Type 1 errors on the basis of place. All the surface characteristics need to be similar, sure. But that’s just the necessary condition. The sufficient condition is PLACE, like a familiar sector or strategy where you’ve had investment success before. I am convinced that we are lulled into complacency by location more than anything else. Yes, we judge a book by its cover, but even more so we judge a book by what shelf it’s on.