What makes investing exciting is that it isn’t always fair. It doesn’t have a clear and uplifting moral. There will be moments when folly is rewarded and prudence is punished. You can actually win by taking the worst bet. You can have no relevant education, no experience, no resources, no connections and still vastly outperform someone with the best education, the most relevant experiences, the best resources and the best connections. This potential for temporary success doesn’t exist in any other profession. If you’ve never trained to be a surgeon, the probability of you performing a successful brain surgery is zero. The same can be said for performing a piano recital. You have no chance in giving a good one if you’ve not trained for it. However, there is an element of luck when it comes to investing.
It is very much like poker.
We can be the most skillful poker player in the world, and still lose to the person across the table. We lose, because we underestimate the power of luck. Imagine we make an obnoxious bet with our friend: We flip a coin five times, if it lands on heads on all five rounds, we’ll give him $100 and if it ever lands on tails once, he’ll give us $20. Lo and behold, the coin landed on heads five times and he starts dancing like Chandler Bing. Will we be emotionally affected? Yes. Will we think twice about taking the next gamble with him? Yes.
Should this example affect any of our investment decisions? No.
We know he was lucky and the odds were already stacked in our favour. It was rational for us to take that bet as it offers a high chance of success. If we feel that it is too risky of a bet, we shouldn’t offer the same terms and conditions on the next episode. This time, we drag out the period of time to increase the possibility of winning. Instead of flipping the coin five times, we flip the coin ten times. Of course, the stakes ought to be higher to entice him. Instead of giving him $100, we offer $1000 and if it ever lands on tails once, he’ll give us $100. Even though we’re more likely to win in the long run, can we actually lose? Yes. But, should we take the bet again? Yes.
This is why we should judge investors by the quality of their arguments, not the performance of their last trade. They might have gotten lucky in a 10-flip streak, but no rational person should try to duplicate that success.
If we flip the coin enough times, we’ll soon discover how luck quickly reverts to the mean. However, many of us fall into the trap of getting stuck on a number. Let’s say our friend really pulled through a 10-flip streak and won a thousand bucks from us. We stop being rational and start believing in his technique with a false sense of confidence. More often than not, we feel terrible not because we made a right decision and the outcome was wrong. We feel terrible, because we’ve just lost a thousand bucks. However, the thousand bucks that we bet on has no bearing whatsoever on the bet before or the bet after this. Probabilities doesn’t care what or how much we bet on. The market doesn’t care how much we put into it or what it costs us. This is the part where we need to manage our risk appetite. It isn’t something to run away from. We need to acknowledge how much we can afford to lose even if we know we’re making the right decisions.
It doesn’t matter how good our cards are. If we cannot afford to go all-in, don’t go all-in. If not, it’ll just be a slow-motion car crash.
Sure enough, from time to time, we’ll hear stories of people who make a big gutsy call and make a fortune. Please understand that on the other end of someone making a fortune also means someone making a loss and if it is a loss we can’t handle, it is beyond devastating. Investing is very much similar to playing amateur tennis. In expert tennis, 80% of the points are won. There are good rallies going back and forth with each stroke louder than before. However, in amateur tennis, 80% of the points are lost. We serve into the net. We hit a little too wide of an angle and the ball goes out of court. In short, we sabotage ourselves into losing. We should focus on avoiding mistakes, and that is the most immediate way not to lose. We don’t need to serve like Roger Federer. We just need to get the ball across the net. Often, we’re so caught up in being fancy at how we serve, we lose the point (literally) of the game.
For investing, we don’t need to find the next big winner. We simply need to avoid the next big blunder.
What we want are good probabilities and favourable odds. What we want is to participate in many games of coin-flipping with the amount we can afford to lose to ride out inevitable bouts of bad luck. Sometimes, bad luck can lasts for years and that is why we don’t want to risk everything on 1 game of coin-flipping. More than that, we want to lengthen the distance between our forecast coming true and needing our forecasts to come true. The market doesn’t care that we need a certain sum of money to get married and buy a house at the age of 32, so don’t expect our assets to rise in price according to how we plan our life. Stacking the odds in our favour with a long enough time horizon will allow us to win eventually. It may not be a king’s ransom, but it is likely to make your queen happy. After all, happy wife, happy life, isn’t it?