The Perils of Performance Over Process

When sports betting sites are looking to promote their services, how often do they highlight the average gains (or losses) of participants?  Never.

It’s way more effective to focus on the relatively small number of players that have achieved exceptional results.

Barry Ritholtz points out that judging investment performance based on one outcome opens yourself up to all sorts of behavioral biases, including availability bias (assuming this one example is representative of a larger theme) and survivorship bias (drawing broad conclusions from limited data).

OK, so the key is to look at a much larger set of results to better evaluate the skill of an investor.  Right?

Not so fast.

Investors often credit their successes to skill (I outperformed because I have a solid investment process) and attribute their failures to poor luck (I underperformed because the market just moved against me).

To reverse that thinking, we rarely think of outperformance as based purely on luck, or underperformance to be the result of a poor investment process.

In short, we assume that better performers have better processes.

The key is to have strong performance based on a strong process. 

As Nassim Taleb suggests in Fooled by Randomness, we often miss the oversized role that chance plays in our lives, and not just with investing.  There’s a random nature to much of our lives, but humans are hardwired to see patterns and assume there are causal relationships at work.

Let’s say we reviewed the performance of 10,000 investors over a period of time.  Based purely on chance, some investors would do better than others.  It’s fair to say that a relatively small number of investors would have very outsized gains.

Strong performance but a weak process tends to be unsustainable.  Impressive returns in this case are more likely due to chance.

Strong processes but weak performance is sort of like climbing up a ladder then you realize it’s leaning against the wrong tree.  Nice job climbing up, but you didn’t really get to where you needed to go!

The key is to have strong performance based on a strong process

Now here’s the important question… Over which of those two pieces do you have direct control?

A mindful investor is always reviewing their daily and weekly routines with the goal of upgrading their investment process.  Whether it’s what you read, how you analyze the markets, or even how you center yourself mentally, there’s always room for improvement.

Thomas Jefferson is often quoted as saying, “I’m a great believer in luck, and I find the harder I work the more I have of it.”

What small step can you take today to put yourself in a position to succeed?


Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. Please see the Disclaimer page for full details.