From Sept 2018:
Over the course of a day we make millions of decisions. Which hand to use to turn off the alarm? How hot to turn the shower? How long to brush teeth for? What to wear? Most of these decisions do not have a big impact on our lives. By far the greatest portion of decisions are made automatically and we are not even conscious of them. Some decisions require more thought such as what job offer to accept or what to invest in. A common error that we make is that we often judge our past decisions by the outcomes. Instead we need to focus on the process of making big decisions. Rational decisions can sometimes lead to poor outcomes but over a long period of time if we maximize our rational decisions, we are likely to improve our lives.
The 1995 Decision to Invest in Amazon
Jeff Bezos, Amazon’s CEO raised $50,000 from about twenty investors in 1995 for about one percent stake in the company. Today that stake would be worth over $3 billion dollars. Perhaps great judgement was used by these investors at the time, but it would be wrong to assume that their original decision was brilliant because of the current outcome. The soundness of decision should be judged by what the facts at the time of the decision revealed. Amazon subsequently borrowed $2 billion dollars and was on the verge of bankruptcy after the dot com bust. Furthermore, not all of those original investors had the exact same reasoning for investing with Bezos. Perhaps some were family members who at some level were investing in Amazon out of kindness. Others may have invested a small portion of their wealth much as they would buy a lottery ticket. Others, may have studied Bezos’ character and the future of internet and invested after evaluating those risks.
What about investors who bought the stock in 2000 signing on to Bezos’ vision? Those investors lost about 90% of their capital after the dot com bust. Did they make a good decision? Was the outcome good? In order to really assess the soundness of the investors’ decisions we have to blind ourselves from the eventual outcome that resulted and ask those people to explain their reasoning.
Suppose instead of investing in Amazon, a person bought $50,000 worth of lottery tickets. We would not even have to hear whether any of her tickets hit the jackpot. From an investment standpoint we can immediately make the judgement that this person made a poor decision since the expected value of lottery tickets is less than the cost of a ticket typically. Hence when evaluating the person’s decision, the outcome of the lottery tickets is irrelevant.
Decisions versus Outcomes
We make good decisions that result in poor outcomes and poor decisions that result in good outcomes. Too often we judge our own and others’ decisions by the resulting outcome. To complicate matters more, we often measure outcomes incorrectly. For example, President Trump along with Congress passed and enacted large tax cuts in 2017. Two questions:
1) Were the tax cuts a good decision?
2) Did they result in a good outcome?
Those are very difficult questions and no doubt many have strong opinions often clouded by partisan bias. Most people end up answering the same to both questions (i.e.: yes/yes or no/no). Outcomes are difficult to judge because we can never be sure what the world would be like with an alternative decision. Furthermore, what time frame do we use when judging outcomes? Someone may argue that the tax cuts have been a boost to the US economy that have resulted in unemployment rates of multidecade lows. This proves that the tax cuts were not only beneficial to Wall Street as evidenced by rocketing stocks but also to Main Street. Alternatively, someone else may argue that the tax cuts have resulted in large deficits despite a booming economy. This clearly contradicts Arthur Laffer’s, (Trump’s economic advisor) theory that tax cuts boost growth so much that tax revenues actually rise and lower deficits. Running record deficits during boom times may not be prudent fiscal policy. Do we judge the outcome of tax cuts now or when the next recession hits?
The Trouble with Money Management Decisions
One of the problems with investing with hedge funds or mutual funds is that investors usually are not on the same wavelength as the managers. A money manager’s time frame may be quite different that theirs. Frequently investors are unaware of the manager’s reasoning for certain investments. Perhaps the manager invested in Nam Tai, a company that I have written about in the past. This stock could easily lose seventy percent of its value in the next two years as I have written before. You could incorrectly judge the manager after the initial loss of capital and cash out before the stock really takes off. The solution to this possible error would be to really understand the manager’s rationale and reasoning for her investments. Of course, if you take the time to understand that then you may as well do the investing yourself. Perhaps this is why most fund investors are easily beaten by index fund investors.
Berkshire Hathaway has been one of the best investments since Warren Buffett took it over in the 1960’s. Investors who bought the stock and held it for a prolonged period have done very well relative to the major indices. However, many who bought without understanding Buffett’s investment philosophies may have bought and sold at the wrong time. For example, in the late 90’s Berkshire significantly underperformed the market. Many decried Buffett’s investment acumen and thought that his skills were obsolete in the new internet economy. They pointed to its depressed stock price as evidence. Investors who judged Buffett’s decisions by using the stock price as a proxy made a colossal mistake at the time.
In the late 90’s, Jeff Bezos told executives and employees to not judge themselves by what the stock price was doing. If the stock went up 30%, it did not mean they were 30% smarter. Someday the stock would drop 30% and if they judged themselves the same way then that would demoralize them since the implication was that they were 30% dumber. Amazon’s daily stock price is certainly no measure of the soundness and quality of decisions made by its managers or investors.
The Trouble with Safety Decisions
One of the biggest problems with the US healthcare system is unnecessary diagnostic tests, procedures, and prescriptions. We wrongly assume that those decisions and interventions are good because the outcomes are good. We assume that without those interventions we would be worse off. After all we are alive perhaps because we are on such and such medicine or underwent a particular procedure. A quick look at comparable countries where far less is spent on healthcare shows us we could spend far less and actually improve health outcomes.
After the September 11th attacks, The US adopted new airline security measures. These measures cost the government and airlines billions of dollars. If we include increased wait times and new frustrations for travelers, the cost would be much higher. Some may point out that the fact that there have been no major terrorist attacks since then proves that the new measures have been a success. But is that really an appropriate outcome measure to judge the success of TSA and new security measures? How likely is it that the terrorists would employ the same strategy as they did on September 11th? After all, wouldn’t citizen’s vigilance have thwarted similar attacks? In fact, thousands of additional people died in 2001 as a result of increased automobile accidents caused by the drop in air travel.
We make millions of decisions daily. Fortunately, most of these decisions do not make a big difference in our long term being. It is important to not judge decisions by their outcomes. Good decisions can lead to poor outcomes and poor decisions can lead to good outcomes. Examining outcomes alone can be misleading and can cause us to mistakenly reward poor reasoning and decision making. Our goal should be to maximize sound judgement and reasoning. You are neither right or wrong if your decision has led to a favorable outcome. You are right only if you use sound reasoning when making decisions.