Investing for Results - Rules, Tools, Judgments, Lessons
Success is built on repeated failures. Remember Thomas Edison? Think of the different kinds of failure. One comes from not trying out your ideas because you are afraid, or because you are waiting for the perfect time, or because you don't have sufficient capital. But you'll never learn by not taking action. Action is the second way of learning. Even if you are unsuccessful what you may have lost is outweighed by what you have learned. Repeated failures toughen your spirit. If properly understood they will open a path to a solution. It's always appropriate to minimize losses, but persistence pays. What's needed is a framework to recognize, understand, accept, and act on successful patterns. There are two types of people in the world: smart people and wise people. Smart people learn from their mistakes. Wise people learn from someone else's mistakes.
"Good judgment is usually the result of experience, and experience frequently is the result of bad judgement" - Robert Lovett. Trying to avoid all loss is a loser's curse. You won't win every point in every game, you'll win some, and you'll lose some. What should be studied are the factors involved in applying methods. It not just knowledge that matters, but understanding and application of its principles. Losses are a learning opportunity. Many times losing is associated with games; the concept of profit or loss gets confused with win or lose, or right and wrong. Losses may be internalized by the individual experiencing them, or may be external and objective. Eliminate your ego from influencing your decision making process and you will produce better results.
Facts are neither right or wrong. They simply are. A fact is something that can be objectively verified. Opinions of events are personal assessments which may or may not correspond with fact. Producing results is not about being right or wrong, nor is it about failure. It's about results. Decision making is a process, a judgment, a choice between alternatives when all facts are not yet (and cannot be) known. The future depends on events as they unfold. In hindsight decisions may produce "good or bad" results. Results are neither "right nor wrong", they simply are. Make a commitment to planning and then take appropriate action to influence future returns.
When individuals face loss they go through stages. There is a book on Death and Dying by Elizabeth Kubler-Ross. She describes five stages; denial, anger, bargaining, depression, and acceptance. Hope usually persists throughout. Death is a discrete event. Investment management is a continuous processes. Continuous processes have no predetermined ending, they go on forever. Learning is also a process. Think of the difference between these discrete and continuous processes. Understanding that will allow you to keep going, and to look forward to tomorrow.
Everyday life is a risk ("Life is trouble. Only death is not." - Nikos Kazantzakis, Zorba the Greek). Estimating and managing risk is a necessary part of life. Crossing the street is a risk, driving a car is a risk, getting married is a risk, and so is having children. Risk is defined as the possibility of suffering a loss (it's a probability only if you can assign a numerical value to the likelihood of the loss). In many of life's activities there is no guarantee of success or of having things turn out the way you want. Peter Drucker called 'inherent' risk that which is coincident with the commitment of present resources with the expectation of future results. Investing is a long term event. Traders are in the business of 'making a market'. Speculators buy for resale (flipping - where price appreciation is the sole expected return). Gambling is entertainment (its distinguishing feature is that it deals with the unknown, with pure chance). Investing keeps you continuously exposed with a current commitment of resources in expectation of future results.
Discrete event outcomes are independent. Yet we often overvalue the low probability of a high gain (have you played the Mega Millions jackpot?). Further, we tend to overestimate the frequency of infrequent events, and often confuse unusual events with low-probability events. Risk, exposure, and probability: the definition of risk is to expose yourself to the chance or possibility of an outcome. Unique events don't have a probability. They are non-repeatable. Focusing on your exposure allows you to manage your downside. Thinking of the upside does not make it so. Always cover your downside.
Rewards, Emotions, and Responsibility
There are only two kinds of rewards in this world, recognition and money. Examine the reasons for the behaviors you exhibit, not your activities. Man is extremely uncomfortable with uncertainty and tends to create a false sense of security by substituting certainty for uncertainty. Emotions are neither good or bad. They are strong feelings that arise subjectively rather than through conscious mental effort. They are part of life. It's emotionalism that should be avoided or controlled. If you don't have conscious control of your actions then your emotions or biology have control of you. An individual who acts after reasoning, deliberation and analysis remains in control.
Rules, Tools, and Planning
In the words of financial editor James Grant, "Because the future is always unfathomable, there are always buyers and sellers in every market. If the future could be accurately divined, markets would disband because nobody would ever take the losing side of a trade." Human activity inextricably involves risk for the simple reason the future is not certain, it never completely reveals itself. The rules of natural science do not render the future predictable. Successful investing is the result of disciplined speculation. Dividends and interest do not simply materialize. Think before taking action. Develop your schemes, programs, and methods for the accomplishment of your objectives. To plan means to think before acting, not to think and act simultaneously, nor to act before thinking.
Decisions you make depend on your goals and objectives. No single method is satisfactory for everyone. Analysis will not tell you what to do or when to do it. To translate analysis to action you need to define what constitutes opportunity. Rules should be developed to implement actions. Analysis tools have flexibility in how they are used. But you must develop the parameters that will determine how and when you will act. How? By doing your homework. Your action rules should be "if...then" statements that result in well thought out responses to events when met (that's Ray Dalio's Bridgewater's investment approach). As Peter Drucker reminded us: "There is no perfect decision."
Everyone would like to know the secret ingredients. But it's not just the ingredients, it's the entire recipe. No one plan works for all individuals. If the future doesn't happen as you expect, be prepared to create it. The only results you will really value are the ones you earn.
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Paul Lechner Esq., CPA
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