A good investment is not determined by results.
To many, this statement will seem controversial. However, those that understand how success in any endeavor is achieved in life will not find it controversial at all.
Good Technique In Sports and In Life
In basketball, you do not judge the quality of a shot by whether it goes in the basket. Nor do you judge the quality of a basketball player by whether a particular shot or series of shots scored.
The quality of a basketball shot is based on the application of proper technique.
For example, if a player takes a shot when closely guarded, from far away, off balance and/or with a jerky motion, this is a bad shot - regardless of whether it scores. A good coach will reprimand the player that just scored and sit him/her on the bench for a while. Indeed, good coaches know that one of the best ways to instill good technique is to punish bad form when it leads to a good result, even more than when it leads to a bad result.
On the other hand, a good player may maneuver perfectly to create an open shot from a good range and execute the shot beautifully in terms of technique, and yet the attempt simply will not go in. Indeed, even the very best basketball players in the world miss about 50% of all jump shots. Thus, a good coach will encourage a player to continue taking good open shots even if that player has missed one or several times.
At any particular point in time there is no guarantee that by applying proper form a player will score a basket. Success at any given point in time needs to be thought of in probabilistic terms. At any given moment in time the outcome is fundamentally uncertain. However, over time, the proper application of technique will with reasonable certainty produce good results.
Readers: Focus on good technique, and the results will take care of themselves. This is one of the most important pieces of advice that I can offer to individual investors.
The Fallacies and Dangers Of A Results Orientation
One of the biggest mistakes investors make is to focus on published performance results. The problem is that investment results - particularly relative performance - are variable even for the very best investors. Even terrible funds and investors outperform a very significant percentage of the time.
Don't be fooled. Results say nothing about whether an investment was good or bad. A monkey throwing darts can achieve a good result on a particular throw or series of throws. Indeed, in a random test, a monkey throwing darts will outperform successful investors over many stretches of time of varying lengths.
As a theoretical and practical matter, the probability of any given investment advisor or fund manager performing better than a monkey throwing darts is quite low. Thus, for all practical purposes, there is little to distinguish the average investment advisor or fund manager from a monkey. However, it is in the nature of things that monkeys will often get a "hot hand." Performance-chasing leads to investors bouncing around from fund to fund, strategy to strategy and advisor to advisor. The inevitable result is disappointment because, in effect, they are simply jumping on the back of one "monkey" after another.
An investor might even be lucky enough to jump on the back of a good investor at some point. But inevitably, that investor will underperform, and the performance chaser will jump on the back of the monkey with "the hot hand."
Worse still, spectacular performance over a relatively short period (even relatively long periods) is often attained through excessive risk taking by the "star" investor. Investors who are lured into jumping on the backs of these monkeys will usually end up in real trouble.
Choose an investment advisor or manager based primarily on an evaluation of their technique.
The Acid Test of A Good Investment Decision
Look at any holding in your portfolio. Ask yourself two questions:
- Is there anything that you could have or should have known at the time of making the investment that would have changed your decision? If so, then the original investment decision was a bad one.
- Is there anything that you could have or should have learned since you made the original investment that caused the expected return of the investment to become unfavorable? The original decision may have been a perfectly good one. However, continuing to hold a position if new information renders the expected return unfavorable constitutes a bad investment decision as of the moment when the new information could/should have been obtained.
Performing this exercise is a bit like watching coaching film after a basketball game. By reviewing film, you can often identify mistakes in the application of shooting technique and you can make the necessary adjustments.
As an investor, it is critical to recognize and learn from errors of technique that were committed by thoroughly reviewing the "coaching film" of past investment decisions. This is one reason that keeping an investment journal is an absolute must for investors.
However, in this regard, it is critical that investors review their decisions properly in terms of process, not in terms of results. For example, quite often, in a basketball tape you can analyze a shot that did not go in and the only reasonable conclusion is: "If I were able to do it over I would neither change the fact that I shot nor would I shoot it in a different way." Remember, the best jump shooters on the planet miss about 50% of their shots. The same happens with investing. Master investors will make many investments that will lose money or underperform.
Master investors continually improve by learning how to discern between "winners" that occurred mainly by chance and those that occurred to application of good technique. They also learn how to distinguish between money-losing or under-performing investments that are attributable to unsound application of technique and those where application of better technique ex ante would not have changed the decision-making outcome.
The main message I want to transmit to readers of this essay is that investment mastery is built by focusing on technique.
Work hard to develop and perfect your own technique and/or learn how to identify good technique in the professionals you hire. Good results will follow in due time.
In a follow-up article I will specifically describe the essence of good investment technique. These basic principles apply equally to both long-term investors and short-term traders. It applies to people that invest individual stocks such as Apple (AAPL), Microsoft (MSFT) or Exxon (XOM) or index ETFs such as (SPY), (DIA) or (QQQ).
Finally, in a subsequent article, based on these principles, I will scrutinize a published investment decision of my own (made in late October) analyzing the "game film" in order to determine whether good technique was applied or not in this case.