Conviction, evidence, and accepting ignorance

Countless studies have demonstrated that incorporating feedback loops into life is beneficial. Want to improve at work; seek a mentor. Want to nix that slice; get a swing coach. Want to get in shape; find a trainer.  Want to become a better surgeon; get a coach. When left to our own designs, discipline falls away and we fail to learn and grow. Investing is no different. Yet, because the topic of money is so taboo, we are often left to our own machinations. I demonstrated in a previous post that you could be one of the best stock pickers in the most competitive arena in investments and still fall short. The basics matter, a lot.

But there are so many questions, what should constitute the basics? Should I hire an adviser? Do I need to pay attention to the economy? Will a trade war kill my 401k? How long will the bull market last? Will Tesla’s Model 3 wait list continue to shrink? Who can I speak to without paying egregious fees? Will Amazon take over the world?

Let’s assume for a moment that there was no cost to having an investment coach and that all discussions were 100% private. This coach is a foremost investing expert. What would you want to discuss with that person?

I actually want to know, take the survey at this link, then come back to this post.




Seriously, do the survey first. It’s three questions.




I wish everyone could have an investment coach—a person that instructs on the fundamentals. I believe that the best financial advisors fill this role, but this coaching aspect is so much more than allocating portfolios and picking managers. Good advisors know that.

Having been in finance for over a decade and worked with one of the best teams in money management, I’ve lived a tour de force of investing lessons. That’s not particularly unique because many people reading this lived through the financial crisis. What is unique is that I've worked for three firms--one that failed, one that is doing OK, and one that is thriving.

The first originated mortgages, the second manages institutional bond portfolios, and my current firm oversees quantitative equity portfolios. It is only through this circuitous route that I have come to grasp what I believe is important to successful investing (Caveat: I reserve the right to change these as I learn more year after year).

  • Unprecedented, almost delusional, conviction

  • Enthusiastic acceptance of your ignorance

  • An evidence-based framework

Though I have written this in bullet point form, it would more appropriately be presented as a circular stream of logic. Let me explain.

Unprecedented, almost delusional, conviction - You must be so confident in your strategy that you can unwaveringly confront your most ardent critics to defend your process. Notice I said process, not decisions. While in my world critics may be a client suffering through poor performance, in yours it may be a significant other concerned about a declining 401k or 529 balance. If you can explain your strategy in a manner that inspires confidence against all emotion, and actually believe it, you are on the right track. If you cannot, chances are high you will change strategy mid-stride at some point in the future.

Enthusiastic acceptance of your ignorance - In a recent piece, I wrote about the drivers of return among professional money managers. One nuance that I did not emphasize enough is that even the best investors are often wrong. This is generally why many great investors hold many positions in their portfolios, and emphasize process over results. Few have delved into this in more detail than Michael Mauboussin. In The Success Equation he provides a framework for thinking about the differences between luck and skill. In activities like investing, which are heavily-luck dependent in the short-term, sometimes good processes lead to bad results. 

We all have poor runs. Inherently we know this through colloquialisms taught at a very young age-- i.e. "don't put all your eggs in one basket". An investor with perfect foresight would only make one investment, the one that appreciates the most. Practically, that's impossible to know in advance so we make educated guesses that provision for our ignorance. We know that nothing is certain so we hedge our bets by owning many investments. Long story short, over a lifetime it would be common for a really great investor’s positions to perform poorly 49% of the time in shorter monthly, or quarterly, observations. Skill only emerges over longer five and seven year horizons precisely because shorter horizons are noise.

An evidence-based framework - Notice that the last paragraph ended with a statistic, 49%. We all have theories on what should and should not work. Reality though can prove to function in a different universe than our own perception. Their are an infinite number of psychological biases that influence our actions. To combat this, decisions should be made with a base rate in mind. Base rates provide a benchmark for which expectations can be managed. For example, since 1900, the S&P 500 (and a proxy for it prior its creation) appreciates in about 70% of calendar years. That means the equity portion of your portfolio will go down in 3 out of 10 years on average.

The ability to draw inference from history is kind of magical. For me at least, it provides solace when shit hits the fan. With an understanding that equity markets will go down at some point in the future, and 3 out of 10 years on average, I am effectively accepting ignorance. I am not capable of timing the market. Yet, I also know that when the markets do turn down, and the client on the other end thinks the world is going to hell in a hand basket, things are probably going to work out OK.

If only each and every one of us had an omniscient confidant to test our convictions, highlight our ignorance, and force us to act with the odds tilted in our favor.