When the market have been running for a good five years, it is difficult to find out if your process is actually doing well. Good processes are usually tested well in the face when risk is introduced.
There are times when as a blogger you are privileged to meet folks that does all this as a profession and not long ago I met up with a value hedge fund analyst who shares with me an experience of his.
Back when he was rounding up his studies at Colombia’s value investing program taught by Todd Combs and Mark Cooper (You may know Todd Combs, he is the one brought in by Buffett to run part of Berkshire’s investment portfolio), the market was at a low in 2009.
So he decided to take that opportunity to start putting what he learnt in the market. And went around picking stocks with the lowest price to book ratio.
That turned out rather well, by 2010, most of his selections are pulling in 80% gains.
And then he made the ultimate confession: "I realize, I have no idea what I was doing"
That to me is a rather startling state. Because, if you see your portfolio nearly doubled, you would have thought that based on the results, your process must be correct.
I believe the value teachings in Colombia must have rubbed off in a certain way to cast enough self doubt in the way he is making his money.
I used to think that this is hindsight bias, but hindsight bias placed more emphasis on time period.
Outcome bias more often judge a outcome that has happen as a validation that what we are doing is correct or not.
Somehow, we often will think about this, or perhaps you are so confident that you know for sure what you are doing is correct.
Many do, and see that since they have 5 years of winners in a bull market, it validates their stock selection, asset selection, wealth building philosophy and methods.
Reading the Good to Great, Outsiders indicates that most of the business that went on to be something more than normal all focus greatly on having great systems, or if they do not have a great system, they have a great system to correct their own system to eventually be great.
I guess as business owners we should be more process and systems focus as well.
It took me the last 6 months to realize some things, that if you are able to only pick the low hanging fruit or easy to recognize dividend stocks, and do very well with them, then perhaps you do have a blindspot in your ability to really do well picking good investments.
It becomes an internal shift that perhaps I am not looking at the metrics with the correct light. I realize that
- having mastered what are safe dividend businesses, I am not capturing the dividend growth businesses, and what are the metrics that identifies a sustainable one
- I realize that I do not have that sturdy of an evaluation of fat tail business risk than I wanted to
- I pondered, do I really want to be in a business that pays out all the cash flow as dividend, stiffing it of any chance to take advantage of better growth
- I realize 25 times PE can be rather cheap to pay for something value wise
- I know that I should learn to build more conviction into the businesses purchase, increase the size of holdings. The holding amount should emphasis that and its monetary impact to the portfolio
- I know I have a massive psychological weakness and I should do something about it
How your system comes under stress test
The way that outcome bias gets exposed is when the system in question comes under risk.
And the best way for that to happen is when the music stops this time.
- You probably realize that you own a few businesses that future cash flow didn’t turn out as you anticipate in a very big way and proceed to dissed that investing should only to be carried out in a bear market
- You realize that your risk assessment still cause some of your business to be imploded and that risk assessment is a waste of time
- You realize that you have a plan to cut stocks when dividend do not lived up to expectations, but that you now have 20 stocks to evaluate in a short period of time as a full time employee. which to cut?
Sometimes I wonder if my brain is playing tricks on me. The problem becomes unnecessary cautiousness, the reward is greater conviction in the evaluation.