I recently read of summary of poker champion turned business consultant Annie Duke's book, Thinking in Bets. Duke describes one of the more common mistakes amateurs make is the tendency to equate the quality of a decision with the quality of its outcome. Poker players call this trait “resulting.”
Another way to describe resulting is confusing the before-hand strategy with the after the fact outcome. This is almost always paired with hindsight bias, which is the belief that we should have known the outcome when the actual evidence at the time of the decision says otherwise. Duke says it this way: “When we say ‘I should have known that would happen,’ or, ‘I should have seen it coming,’ we are succumbing to hindsight bias.” She goes on to say that we tend to link results with decisions even though it is easy to point out indisputable examples where the relationship between decisions and results isn’t really correlated.
Don't Judge Decisions by Good or Bad Outcomes
Here’s an example from poker. As a hand comes to a close with only two players and one card remaining, one player is able to calculate a greater than 70% chance of winning. He bets according to those odds, but loses the hand. At this point he can falsely equate the outcome with a bad decision, which is then likely to alter his future play. Or he can simply accept the fact that high probabilities don’t work every time and then get on with the business of playing according to the odds with each successive hand.
Another example of resulting would be my decision to wear a seat belt. Let’s say I've always worn a seat belt for the last 30 years and never been in an accident. Today, unfortunately, I have to swerve to avoid hitting a dog, coming to a loud and sudden stop via telephone pole. The seat belt does a great job of keeping me in place. After shaking off the initial shock of the crash, and of course checking out the damage to my car, I appear to be uninjured. However, after a little time passes, I notice soreness in my ribs and hips. Upon further review, the seat belt that was intended to keep me safe has actually caused some fairly serious and painful bruising. From today's experience, I could conclude that wearing a seat belt is foolish and I will not do so in the future. The obvious error in this thinking is it ignores the alternative outcomes and the large body of evidence that wearing a seat belt reduces the chance of more serious injury or death.
And now an investment example. Joe works for Amazon and has nearly all his portfolio in Amazon stock. He is now a millionaire based on this strategy and believes that concentrating all his wealth in one basket is the right strategy. Diversification is for those who aren’t as knowledgeable as he is… and he knows Amazon. Joe is validating the correctness of the strategy with the success of the outcome… Joe is resulting. Of course, Joe has to continue making this decision every day and the stakes get higher. Now, go back and read Joe’s story and substitute the name “Enron” in place of “Amazon.” It’s a very different outcome. And the reality is for every Amazon, there are more Enrons (or WorldCom, Polaroid, Kodak, Xerox…). None of the original stocks in the Dow Jones Industrial Index remains in the index. Actually, except for General Electric, none of them are even in business. Joe’s strategy is flawed.
Invest by Consistently Playing the Odds
Just like in poker, there are too many variables and unknowns with investing to be certain of an outcome. The best we can do is put the odds in our favor and remain consistent with the strategy. Just because it doesn’t produce good results every time doesn’t mean it’s broken. A very current and relevant example of this is the “value” premium. Simply stated, value investing says that overweighting stocks that are seen to be undervalued will produce a higher return over time compared to growth stocks. A lot of historical analysis supports this claim and a lot of investment strategies are based on some version of the value premium. However, the last 10 years have shown a large underperformance of value compared to growth, leading many to conclude that it was a mistake to invest this way.
Disclosure: none of the strategies we use in client accounts are based on the value premium. I mention this because (1) it is proper for me to do so, and (2) I need to highlight this omission does not make me, or the investment team, right. We just happen to follow other strategies in meeting client goals. Nor does it make value investors wrong. The takeaway is that once a strategy is selected and until that strategy can be proven to no longer work or no longer be appropriate, it is best to stick with it instead of merely relying on results to invalidate the strategy.
Warren Buffett said investing is simple, but not easy. It takes discipline to earn the returns that come from whatever strategy is being employed. It’s hard to stay disciplined after poor results. Yes, the strategy could be wrong and it is appropriate to question the assumptions behind the strategy. But let the facts bear out its validity, not emotional regret. Annie Duke says early in the book that Thinking in Bets is not about poker strategy or gambling (and it’s not an investing book), but rather a book about making smarter decisions. So the good news is her advice has wide applicability, including several lessons for investors.
Any information presented here is general in nature, believed to be reliable as of the date published and is not intended to be and should not be taken as legal, tax, investment or individual financial planning advice. Competent, licensed professionals should be consulted when implementing any kind of financial, estate, tax or investment strategy.