Investing is a humbling profession. Like predicting the weather, you’re proud if you get things right a mere 50% of the time. That’s tough because it means you’re also wrong a large percentage of the time, and that’s humbling.
This surprises many because they think long-time professionals should be able to do much better. The reality is that predicting the future, especially financial markets, is extremely difficult to do.
I was reminded of this recently looking at the investing records of the best in the business. Investing legends, like Lew Sanders, brag about being right 52-53% of the time. Super-humans, like Warren Buffett, are right 90% of the time. But that still means he flubs it 10% of the time. His 2008 investment in ConocoPhillips is a great example. Even geniuses sometimes get it wrong.
This reminds me, too, of how experts in a field can miss big changes. Tom Watson, the famous builder of IBM, thought there was a “world market for maybe five computers” in 1943. Bill Gates famously missed how the Internet would change the computer industry. If the the most brilliant, successful people in the field can miss things, then mere mortals, like me, have to predict with caution.
How should this impact investment decision making? In two ways, I think.
First, you have to adjust your predictions for the fact that you aren’t going to project accurately 100% of the time. This means buying with a margin of safety (purchasing significantly below what you think an investment is worth). It means using probability theory to adjust your assessments of the future. It also means taking a pass on things you know you can’t predict (Buffett strongly emphasized this in his latest annual report to shareholders).
Second, it means you need to keep track of your ability to predict. How can you adjust your predictions if you don’t know how you’ve done?
I keep track of my predicting ability by comparing how my investment decisions stack up against market returns. If a stock I buy and sell beats the market, I count that as a “hit.” Then I calculate my “batting average” as a percentage of the time I “hit” versus “swing.” I use this batting average to adjust my investment position sizes.
I also keep track of by how much I “hit” and “miss.” You can have an above 50% batting average and do terribly if your hits beat the market by 5% but your misses go down by 20%. Lew Sanders does well because his 52-53% hits go up much more than his 47-48% misses.
My batting average has fluctuated between 55-70% over time. Pretty good, but I plan to get better. Keeping track of my batting average and degree of out/under-performance helps me improve. This will boost my investing record.
It’s humbling to be wrong 30-40% of the time, but without that self knowledge, I can never hope to improve. Plus, being right 60-70% of the time, at least in the investing profession, makes a big difference in results.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.