Please note that for the purposes of this analysis, I use the Norman Kemp Smith translation of Immanuel Kant’s Critique of Pure Reason. Please refer to previous analysis which I build upon.
Pure reason, Kant critiques, leads to speculative endeavors. Moreover, Kant writes that “It is humiliation to human reason that it achieves nothing in its pure employment, and indeed stands in need of a discipline to check its extravagances, and to guard it against the deceptions which arise therefrom” (The Canon of Pure Reason, A 795 / B 824). Instead, pure reason’s only utility is negative, that is, for the purposes of falsification. Nevertheless, Kant still wonders if there is some positive mode of knowledge that belongs to the domain of pure reason. Thus, he turns to its theoretical employment, that which he had been critiquing, to the possibility of its practical employment. Kant posits that “if there be any correct employment of pure reason, in which case there must be a cannon of its employment, the canon will deal not with the speculative but with the practical employment of reason” (The Canon of Pure Reason, A 797 / B 825). Kant concludes, as will be shown, that pure reason is useful in its practical employment, especially in matters of determining principles and in judgement. Investors today can learn from Kant by turning the speculative urges of reasons toward these practical applications, especially in matters of judgment.
Kant begins his discussion of practical reason, that is, reason applied to how one ought to act, by outlining its domain. Kant asserts that practical reason gives us the precepts of prudence, for example, which is a kind of pragmatic reason used for attaining whatever end one has in mind. Kant writes:
“By ‘practical’ I mean everything that is possible through freedom… Thus, for instance, in the precepts of prudence, the whole business of reason consists in uniting all the ends which are prescribed to us by our desires in the one single end, happiness, and in coordinating the means for attaining it. In this field, therefore, reason can supply none but pragmatic laws of free action” (The Canon of Pure Reason, A 800 / B 828).
Prudence is, perhaps, the cardinal virtue of the investor. Analogous to Kant’s aforementioned passage, prudence is a manner of practical reason that allows the investor to achieve his ends, namely that of superior risk-adjusted returns. Reason, therefore, sets forth principles to which we adhere, or ought to adhere, our actions to if we are to achieve our end. On the notion of principles, Kant continues:
“the human will is not determined by that alone which stimulates, that is, immediately affects the senses; we have the power to overcome the impressions on our faculty of sensuous desire… Reason therefore provides laws which are imperatives, that is, objective laws of freedom, which tell us what ought to happen – although perhaps it never does happen – therein differing from laws of nature, which relate only to that which happens. These laws are therefore to be entitled practical laws” (The Canon of Pure Reason, A 802 / B 830).
The human will is not determined solely by stimulus, Kant asserts. Rather, reason creates imperatives, akin to principles, that tell us how we ought to act or what we ought to expect based on the ends in mind. These imperatives derive from reason because they tell is what ought to happen, although as Kant points out it doesn’t necessarily have to always happen. These practical laws, as Kant ascribes them, are the principles derived out of practical reason in accordance with prudence, in the case of the investor. They tell him or her how to act in all similar circumstances without regard to the particular (i.e., without regard to such-and-such security or business). In this way, these practical laws are much akin to a table of commandments or guiding rules that one might take away from reading Klarman’s Margin of Safety, for example.
Reason formulates three questions, Kant writes, which it ought to answer. These questions, one theoretical, one practical, and one mixed, form a synthesis of pure reason with practical affairs. As Kant states, “Pure reason, then, contains, not indeed in its speculative employment, but in that practical employment which is also moral, principles of the possibility of experience” (The Canon of Pure Reason, A 807 / B 835). Of these three questions, Kant writes:
“All the interests of my reason, speculative as well as practical, combine in the three following questions:
1. What can I know?
2. What ought I know?
3. What may I hope?
The first question is merely speculative… The second question is purely practical… The third question… is at once practical and theoretical” (The Canon of Pure Reason, A 804-5 / B 832-3)
The first question – ‘what can I know?’ – is theoretical insofar as the answer is indefinite. In other words, there is no way of absolutely determining it. However, this does not imply that it is not worthwhile. To the contrary, the negative utility of such a question can save a prudent investor from believing that he can know certain things that he cannot. The practical is such because it is a necessary question for any investor who wishes to act intelligently. Whether it pertains to a particular investment or some top-down risk assessment, the investor needs to know what kinds of information he or she needs to make a prudent judgment about the matter. The mixed question contains both theoretical and practical elements. The prudent investor may have hopes, but does not rely on them. Nevertheless, hopes in this manner are of some utility to the investor; like a sailor’s spyglass, it allows the investor to spot possible sources of value creation or risks to be avoided on the horizon.
It should be apparent from the aforementioned questions that practical reason is concerned with judgments in the ordinary course of business. Reason assists our understanding of judgments by allowing us to measure our evidence behind our thoughts. Thus Kant introduces a dichotomy of judgments: convictions and persuasions. Kant writes:
“If the judgment is valid for everyone, provided only he is in possession of reason, its ground is objectively sufficient, and the holding of it to be true is entitled conviction. If it has its ground only in the special character of the subject, it is entitled persuasion. Persuasion is a mere illusion, which lies solely in the subject, is regarded as objective. Such a judgment has only private validity… But truth depends upon agreement with the object, and in respect of it the judgments of each and every understanding must therefore be in agreement with each other” (The Canon of Pure Reason, A 820 / B 848).
Convictions are what the investor ought to aim for; they are judgments deemed valid on the basis of reason, grounded on sufficiently objective evidence, and agreeing with the object in question. On the other hand, judgments based on the special interest of an individual or group, without roots to found on, is mere persuasion, according to Kant. Persuasion is a dangerous form of practical reason, akin to the speculative component that stems for the misuse of pure reason. Kant’s description of persuasion is an apt account of today’s speculator; through some private interest of their own, oft emotion-laden, they make judgments without grounds in objective evidence that do not correspond with the effectual truth of the object of their speculation.
Discerning convictions from judgments is not always a facile task, especially when the judgment in question is someone else’s. Because of epistemic limitations, Kant asserts that it is difficult to affirm convictions. Instead, following the negative utility of reason, judgments are more readily falsified; hence, mere persuasions are more likely to be revealed through rigorous enquiry. Perhaps more importantly, through such enquiry the causes of error in the judgment can be identified and remedied, unless the error lies in the character of the agent. An example of this latter situation would be a speculative individual who regularly acts on mere persuasion due to his or her impetuous character. Kant writes:
“The experiment, however, whereby we test upon the understanding of others whether the grounds of the judgment which are valid for us have the same effect on the reason of others as on our own, is a means, although only a subjective means, not indeed of producing a conviction, but of detecting any merely private validity in the judgment, that is, anything in it which is mere persuasion… If, in addition, we can specify the subjective causes of the judgment, which we have taken as being its objective grounds, and can thus explain the deceptive judgment as an event in our mind, and can do so without having to take account of the character of the object, we expose the illusion and are no longer deceived by it, although always still in some degree liable to come under its influence, in so far as the subjective cause of the illusion in inherent in our nature” (The Canon of Pure Reason, A 821 / B 849).
The relevance of discerning convictions, grounded on evidence and in accordance with the reality of the object, from mere persuasions is of paramount importance to investors. Countless today are the volume of ‘investment ideas’ that are floated around various mediums. Investors need to be able to efficiently sort promising ideas from the superficial and speculative ones. As Kant says, it is more arduous in labor and time to verify each idea by its status as a conviction as compared to falsifying lesser ideas for their speculative elements. Moreover, such repeated exercise can also yield insight to the prudent or speculative character of a particular individual, the investor himself included.
Kant then distinguishes between three modes of holding a thing to be true, or the subjective validity of the judgement, along three degrees: opining, believing, and knowing. Opining is the holding of a judgment that is known by the agent to be insufficient, both objectively and subjectively. Knowledge, on the other hand, is held to be both objectively and subjectively valid. Kant writes:
“Opining is such holding of a judgment as is consciously insufficient, not only objectively, but also subjectively. If our holding of the judgment be only subjectively sufficient, and is at the same time taken as being objectively insufficient, we have what is termed believing. Lastly, when the holding of a thing to be true is sufficient both subjectively and objectively, it is knowledge. The subjective sufficiency is termed conviction (for myself), the objective sufficiency is termed certainty” (The Canon of Pure Reason, A 822 / B 850).
Opining is akin to the mere inclinations and whims of speculation – all unvalidated statements like ‘such-and-such company is a great business’. Statements like the aforementioned one are purely subjective and neither objective unless supported by reasons. Investors ought to be extra cautious to avoid opining like this even though the opportunities to do so are ample and the impetus is equally strong. Kant advises much of the same:
“I must never presume to opine, without knowing at least something by means of which the judgment, in itself merely problematic, secures connection with truth, a connection which, although not complete, is yet more than arbitrary fiction. Moreover, the law of such a connection must be certain. For if, in respect of this law also, I have nothing but opinion, it is all merely a play of the imagination, without the least relation to truth” (The Canon of Pure Reason, A 822 / B 850).
In a judgment, so as to avoid opining, one ought to have some truth principle behind that judgment that is certain so as to ground one’s judgment. For example, the investor ought to be weary of opining based on fallacious principles, such as ‘risk can be diversified away’ or ‘housing prices never fall’ (which was a common phrase among speculators pre-2007). On the other hand, opining can be less deleterious when grounded on certain principles, such as ‘such-and-such company appears to be at historically high profitability, I’m not sure it is sustainable given the forces of reversion to the mean’. Such an example is opining because it is based on an inclination, not fact, but is sensible as it is secured by a near-certain principle (reversion to the mean, in the aforementioned example). Thus, of opining Kant concludes: “we must not venture upon an action on the mere opinion that it is allowed, but must know it do be so” (The Canon of Pure Reason, A 823 / B 851).
Prudent individuals ought to avoid opining, Kant advises, they ought to also avoid thinking that their judgments consists of true knowledge, rather it is belief. As Kant states, “on the other hand, while opining is doubtless too weak a term to be applicable, the term knowing is too strong” (The Canon of Pure Reason, A 823 / B 851). Pure reason tells us that we cannot know things with certainty because we do not know things-in-themselves, but from a practical point of view, the certainty we intuit can be termed ‘believing.’ Belief consists in accepting an end as fixed – superior risk-adjusted returns for the investor – which creates hypothetically necessary means to attain the end in mind. While we can never have certainty with the end, belief in the end allow practical reason to identify and choose the means necessary for these ends. Kant writes:
“But it is only from a practical point of view that the theoretically insufficient holding of a thing to be true can be termed believing. This practical point of view is either in reference to skill or in reference to morality, the former being concerned with the optional and contingent ends, the latter with ends that are absolutely necessary. Once an end is accepted, the conditions of its attainment are hypothetically necessary. This necessity is subjectively, but only comparatively, sufficient, if I know of no other conditions under which the end can be attained. On the other hand, it is sufficient, absolutely and for everyone, if I know without certainty that no one can have knowledge of any other conditions which lead to the proposed end. In the former case my assumptions and the holding of certain conditions to be true is merely contingent belief; in the latter case it is a necessary belief” (The Canon of Pure Reason, A 823-4 / B 851-2).
For practical purposes, contingent beliefs are most relevant for investors. Kant illustrates contingent beliefs using the example of a physician who must do something for a patient in danger, but does not know the nature of his illness. He observes the symptoms, and if he can find no more likely alternative, judges it to be a case of such-and-such illness. This estimation is a contingent belief, yet it forms the ground for the actual employment of means to certain actions. Hence, such beliefs are nonetheless pragmatic.
Kant provides another example that is especially apt for investors today, that of wagering. Kant illustrates how an individual’s conviction of their judgments wavers with the stakes. At no or low stakes, individuals are prone to assert a mere persuasion with uncompromising assurance that there could be no possible error in his judgment or the expected outcome. On the other hand, at a higher wager, the self-assured individual begins to doubt himself and his judgment. Kant writes:
“The usual touchstone, whether that which someone asserts is merely his persuasion – or at least some subjective conviction, that is, his firm belief – is betting. It often happens that someone propounds his views with such positive and uncompromising assurance that he seems to have entirely set aside all thought of possible error. A bet disconcerts him. Sometimes it turns out that he has a conviction which can be estimated at the value of one ducat, but not of ten. For he very willing to venture one ducat, but when it is a question of ten he becomes aware, as he had not previously been, that it very well be that he is in error… Thus pragmatic belief always exists in some specific degree, which, according to differences is the interests at stake, may be large or small” (The Canon of Pure Reason, A 824-5 / B 852-3).
Kant highlights how beliefs are pragmatically measured by practical reason. More candidly, the higher the stakes, the more our practical reason scrutinizes the possibilities of experience. The reason for this is that at higher stakes, the more our interests are vested in the outcome, hence reason, weighing the magnitude of the possible consequences, speaks up over the emotions. In addition to this lesson, investors can learn to use this hypothetical wagering to question the foundations of our decisions – ‘am I so confident in such-and-such investment opportunity to make it my largest position, why or why not? – and allocate capital accordingly.
Kant hopes to have shown that when reason is anchored by the bounds of possible experience, it can avoid its speculative errors. This is the manifestation of pure reason, given that it is still departed from from the objects of experience, which only has a negative utility. This form of reason is useful for investors to create and falsify investment principles or investment theses. However, when reason is directed towards – and not just anchored by – the bounds of possible experience, it can have a positive utility as the manifestation of practical reason. This form of reason assists us in determining the best ends to accomplish what ends we have in mind; these ends being determined by the affects of our pure reason. Practical reason thus has a paramount role in judgment, in particular. Ultimately, Kant concludes: “Thus even after reason has failed in all its ambitious attempts to pass beyond the limits of experience, there is still enough left to satisfy us, so far as our practical standpoint is concerned” (The Canon of Pure Reason, A 828 / B 856). The prudent investor ought to cultivate both forms of reason – pure and practical – so as to set proper ends and be able to identify the best means for these ends.