Integrity Competence Prudence
Outcome or Process
Here is an excerpt from a weekly piece Barry Ritholtz writes for Washington Post:
Has this ever happened to you?
In the course of a conversation, you learn about an acquaintance or colleague who made an unusually successful investment. For whatever reason, they put capital at risk into XYZ and the returns were extraordinary — far more than what is typical for your investment returns.
In that situation, which of the following comes closest to your immediate thoughts?
- I wish my 401(k) was filled with XYZ !
- If only I had his access to his inside information.
- How much time and effort goes into his research?
- What does his win/loss ratio look like? Gains vs. losses over time?
- Sounds like he got really lucky.
If your thoughts were along the lines of answers 1 or 2, you are, like most investors, outcome-focused. If your thoughts were along the lines of answers 3 or 4, you are in the minority, and are process-focused. Answer 5 can fall into both camps, but the significance of each depends on the context.
Let’s define these two so you have a better sense of what is under discussion.
Outcome is simply the final score: Who won the game; what numbers came up in a roll of the dice; how high did a stock go. Outcome is the result, regardless of the method used to achieve it. It is not controllable. You can blow on the dice all you want, but whether they come up “seven” is still a function of random luck.
Process, on the other hand, is a specific methodology. It is a repeatable approach to any challenge or endeavor, be it construction or medicine or investing. And you can control a process.
What kind of people are outcome-oriented? Gamblers, many (but not all) sports fans and, of course, speculators.
What about the process-oriented people? They include airline pilots, professional sports coaches and, of course, long-term investors.
Wall Street thrives by appealing to our tendency to be outcome-focused. We rank fund managers, best asset classes, top-performing sectors, highest-returning mutual funds. Note that all of these are ranked not by repeatable process, but by outcome. This is a brilliant bait-and-switch. You don’t know if these outcomes were the result of dumb luck or one-time events or simply a turn of the cycle. The tease is that you, too, can have these fabulous returns if only you invest in these products. Here is the next XYZ, yours for the taking.
If only. A funny thing happens the next year: A whole different set of outcomes “wins.” Different sectors lead, another mutual fund is on top, a new manager is top dog. Last year’s top performers? That was last year! Here are the new winners, ripe for your investment dollars. Wall Street engages in this classic outcome-oriented advertising because it pushes people’s buttons. It sells.
It is not just that “past performance is no guarantee of future results.” But rather, that is an actively misleading goal, the legalese in fine print belied by the headline promise of great riches. I call that “the dangle.” It is the tease that suckers investors in. Any Wall Street advertising that does not go into the boring details of methodology is most likely to be pushing past performance.
Which brings us back to our earlier questions: If you said of your colleague who made all that money, “sounds like he got really lucky,” you are probably on to something. (To the outcome-oriented investor, it may just be sour grapes.) But the process-oriented investor knows that dumb luck is not a repeatable event. It is not anything that can be relied on over time. Indeed, eventually, random outcomes all revert to the mean, meaning that streaks eventually end. Understanding this is a key part of intelligent and rational investing.
Process-oriented investing is a long-term approach to putting capital at risk by owning a broad variety of asset classes, making periodic contributions and regularly rebalancing. You can just hear the marketing guys screaming, “Boring! How can we ever sex up that sort of approach?!”
Focusing on your investment process, and not the outcome, should be your goal. Here is the payoff: Over the long term, a good process delivers highly desirable results, and generates better and more reliable outcomes. There is nothing boring about that.