In her bestselling book, Thinking in Bets, Annie Duke, former World Series of Poker champion, refers to a very interesting topic called “resulting.”
Resulting is when we observe an outcome and then decide whether the choice that led us to that outcome was right or wrong.
If the outcome is great, we may feel that the choice was great. If the result is bad, there may be a tendency to believe the choice was bad.
But all of this completely ignores the elements of circumstance and luck.
Let’s take a moment and apply resulting to investments.
An advisor recommends a diversified portfolio to you. Some of the investments do incredibly well, while others do poorly.
Based on the information at hand, the answers to the above may be impossible to determine.
A good advisor, who is looking out for your best interests, will find investments that have the best chance to perform well, and combine those with your personal risk tolerances and time horizon, and then make choices for you based on these considerations.
The key phrase here is “best chance.”
Does this mean the advisor is flipping a coin, or is perhaps a magic investment genie?
No. It means that he or she is trying to assign probabilities to certain things that might happen.
But there are still never any guarantees.
Purely for the sake of example, let’s say the probability that we place on a particular investment holds a 90% chance of having a good result over the next 20 years.
90% is very high. Most people would like those odds. But does this mean that the investment is assured of success for the next 20 years?
Of course not.
There’s still a chance (statistically, in this instance, ten out of 100 times) that things could happen that are outside of what would be considered likely.
So, when you invest, what should you consider?
First, you need to accept that all investments contain risk. If you ever meet anyone who tells you that an investment is a “sure thing,” be highly cynical about that advice.
Second, make investment decisions only at unemotional times. You merely need to think back to the housing market of the last decade to know that just because an investment is skyrocketing in value today, that doesn’t mean that trend will continue in the future.
What goes up, almost always comes down. And if something’s on fire, how much fuel is left to burn before that fire peters out?
Lastly, choose your advisor carefully. A good checklist to review your investments against the recommendations of an advisor (to help you maximize the potential for good outcomes) would be:
If the investments are being recommended merely because they help the advisor get paid, all things being equal, the chances are high that the recommendations are not what’s best for you. Only agree to work with a fiduciary advisor, and always ask them right up front how they get paid.
If the answer is yes, that’s great. If not, you’ll need to make sure the investments are changed to meet all your liquidity needs, risk tolerances and objectives.
If the investments are concentrated in certain hot sectors, then the advisor may be betting your savings on the hope that all these things are going to work perfectly. The other concern here, is that your investments are too “highly correlated” with one another, which is almost never a good thing.
We call these highly-correlated investments “crowded trades.”
Crowded trades are when someone gets invested in just a few areas that are doing exceptionally well. And, certainly, those investments could all continue to do well for a while. But, at some point, everyone will want to unwind those trades, and that can be ruinous when it happens.
Having a diversified portfolio means that you will almost never hit five consecutive grand slams, but it also means that you won’t likely be striking out many times in a row, either. The key is not how today’s game goes, but where you are in the standings at the end of the season.
Building probabilities using lots of potential scenarios—such as applying stress testing—ensures you aren’t married to any one outcome. And, favorably for you, this will help to make any “resulting” that occurs along the way more likely to be of “the investment choices I made were sure great” variety, which is something all savers and investors would like to be able to say again and again and again.