With Uncertainty, Process Always Trumps Outcomes

The markets are filled with uncertainty and most investors are focused on short-term outcomes. This is a destructive combination, and may be a contributing factor to investors performing so poorly.

Learning From Casinos

If a casino has a bad weekend – let’s say it lost $100 million, it really doesn’t care. Why? Because it knows the process is correct. Casinos understand uncertainty, and that sometimes luck will be with the gambler. With that understanding, they also know that so long as the game continues, they will win in the long run. Because the process is correct.

Can you imagine a casino opening up, experiencing significant loss the first weekend and promptly abandoning the process and “cashing out”? That would be ridiculous. Yet, we investors do that all the time. The reason? We don’t understand uncertainty and we don’t have a robust investment process.

Process Trumps Outcomes

Go back to Super Bowl XLIX, the famous last play of the Seahawks where they opted to throw a pass (that was intercepted) rather than run it. It was called the “worst Super Bowl call in the history of the Super Bowl”. What made it so bad? Was it because it was intercepted? What if it was caught for a touchdown? If it had ended in a touchdown, it would have been called a brilliant decision. Sure, the outcome was unfortunate. But that decision actually had very favorable odds of success. We can’t let outcomes alone determine the wisdom of our process/decision.

Uncertainty & The Outcome Bias

Super Bowl XLIX is a perfect example of the outcome bias. We tend to evaluate the wisdom of our decisions based on short-term outcomes. But when we are engaged in events with uncertain outcomes, such as investing, we will get unlikely outcomes from time to time. We get it when playing blackjack, but are completely blind when investing.

Example-Blackjack: Let’s say I am dealt 18 and the dealer is showing a face card. If I were to double down, you would say that is a foolish decision, and you would be right. The odds are so against me, and I’m doubling down. But what if I got a 3 and won the hand? Doesn’t matter, it would still have been an awful decision…I just had a lucky outcome.

The same things happen with investing. We invest in a given stock without any plan or defined process. Maybe it was a hot tip from a friend, or maybe our gut was just telling us to do it. If the stock subsequently goes up, we tell ourselves how good we are. We just have a different style than everyone else. We don’t see it as luck. For some reason we get it with gambling, but we don’t when investing.

Focus on Process

Many investors will look at their performance often. Some will require their advisors to perform quarterly performance reports. For what purpose? Well, because the outcome bias is at play. And if the outcomes are poor, they are likely to change their strategy/process. And this “performance chasing” continues on and on.

It would be much more productive when evaluating our portfolio to ignore the short-term performance, and focus instead on whether we stuck to our process, even if it didn’t work in the short term. This may not be easy, but it is essential if we want to improve our returns.