Process and Outcomes

In times of great market turbulence, it is a natural tendency for us to focus on market developments and on the turbulence. Stocks and discussions on stocks and the markets often assume prominence at parties and social gatherings. So we tend to discuss the state of the markets, what caused the turbulence, how things have panned out, what markets would do next and what we should do in response or in anticipation of market moves.

Each of us will have an opinion. Such opinions are often biased by our personalities, the recent performance of the markets, our positions in the markets, etc. For example, a cautious person might see more pain ahead. An utter pessimist might go to an extreme and paint a very bleak picture of the world. A sadist might take pleasure at others' losses and pain. An optimist might see market bottoms. Someone who is long might hope the markets recover, while those who are short might get biased by their position and expect further declines.

We are almost never objective in our analysis, much as we want to be or believe we are. Call it the limitation of the human mind. The truth is that markets are always uncertain and we are rarely objective. This is a deadly combination in analysing any situation. Uncertainty means we dont know what might happen. Being biased means we see possibilities where none exist. No wonder market analysis is so tough!

And then we make an investment decision. Any investment decision can only lead to three outcomes: we either make money, lose money or break even. And investors tend to focus merely on the outcome: whether or not the investment was profitable. This is understandable. At the end of the day the bottom line is all that matters. And outcomes can be seen objectively, the Profit&Loss statement states clearly whether the outcome was favourable or not.

But every outcome is a derivative of a process. An investment outcome is a derivative of some thought process and some analytical process (however sound or unsound that process might be). A focus on achieving outcomes (money to made somehow, anyhow) might make us neglect the all important process. It is the process that leads to results.

There are perils of evaluating the process from the outcome alone. It is seen that if the outcome is favourable, we assume that our thinking was correct and we made a good decision. If the outcome is unfavourable and we lose money, we assume a flaw in our analysis. Can we really make this conclusion? Hardly!

Any domain where outcomes are uncertain, is governed by probabilistic models. Many times, a sound process could lead to an unfavourable outcome (bad luck). Conversely, a flawed process could lead to a favourable outcome (good luck). On other occassions, a good process could mean a good outcome (deserved success) and a bad process can lead to a bad outcome (poetic justice). You can toss a coin to decide whether to buy or sell. If you make money, thats by sheer luck. If you lose money, you deserved to lose, life is fair! On the other hand, you can have a very logical process to invest. Should you lose, bad luck! Should you win, congratulation, you deserved your success.

In the longer run however, repeated several times, a good process will lead to a good overall results while a bad process will lead to a bad overall results, though any single outcome could be divorced from the process. A good process acts like a light house for our investing decisions. It creates a framework for decision making and limits the biases that creep into our thinking. A good process guides out thinking and keeps us from making random decisions.

Many investors go about investing in random methods, often guided by emotion, gut feel and market sentiment. Sometimes they make money, sometimes they lose it. Over the long run however, without a solid guiding process, they find little progress in either their investing knowledge or their net worth. So the next time you find yourself discussing stocks in a social gathering, you might want to stop discussing outcome and start discussing process. You would do yourself a lot of service in focussing on the process above the outcome. Using a sound investment process makes investing far less stressful, profitable and, unfortunately, quite boring.

Happy investing!