The difference between process and outcome
1Earlier this year I had a stretch of bad investments. I lost money. I was checking my portfolio multiple times a day and trading in and out of the ‘next hot meme stock’ - all to find a shortcut to big gains. I strayed from my long term strategy, and my results suffered. This resulted in me selling several positions at a loss, and wasting time chasing opportunities. After some reflecting, I realized why this happened.
Imagine stepping into a shower and turning it on, excited for that perfect water temperature. But you've never used this shower before, so you don't know where to position the knob to reach the perfect temperature. There are no hot/cold indicators on the knob either.
Also, this shower is different than a normal shower. When you turn the knob to a given setting, there is a delay until the water reaches the new temperature. You have to wait before you're able to get feedback on the setting you've chosen.
But here's the real catch - with this shower, the length of the delay is random and unpredictable. It could be two seconds, or two minutes. So with each movement of the knob you're met with an undefined period before you know whether to increase or decrease the temperature to reach your desired level.
Sounds pretty frustrating right? Well, that’s investing.
Outcome vs. process
I love this analogy because it really gets to the crux of why investing is so hard, and why most investors underperform the S&P 500. Investing is hard because we confuse the outcome with the process, and this is what gets us into trouble. In investing, we make decisions based on limited information, and ideally we follow a process, but we don't know if we are making the right decisions or whether our process is working until much later. We make investments which may not pay off for years.
There’s a delayed feedback loop. And if you can't stand there under the freezing water, waiting patiently, then you're probably not going to be able to get to the perfect temperature. You need to become accustomed to delayed feedback and gratification.
So what is process? It depends on you. Your process may be passive, using automatic monthly investments into low-cost index funds (dollar cost averaging). Or, it could be investing in individual stocks in a specific sector, and performing rigorous due diligence on each company before allocating a fixed amount of your portfolio to each stock. Your process should be personalized to you and your goals.
What is outcome? The outcome is what you really want. Outcome is the fat brokerage account balance. It’s becoming a millionaire. It’s the big gain you had on that meme stock. Or perhaps your desired outcome is more long term: a comfortable retirement, paying for your grandkids education, being able to give generously to charity. The outcome is the destination.
It’s wonderful to have financial goals - that’s why we invest in the first place! But make sure to separate your goals from the short-term outcomes you crave. Keep the long-term goal in mind, while committing to the process now, and pay less attention to the short-term outcomes.
Follow the winners
Athletes understand this concept well. They understand that when they line up at the start of the race, 99% of the outcome of that race has already been determined by the their preparation up to that point. The one who crosses the line first probably doesn't 'want it' more than any of the others. It's the thousands of hours of training before the race. It's the intensity of that training. The strategy and planning that went into it, and the supplementary habits like diet, stretching, and physio.
It is the process of preparing for the race that wins the race.
In athletics, process drives outcome. The outcome is the win, the gold medal, the cheering crowds. The process is everything else. Investing is the same - the big portfolio balance is the outcome, but the process is disciplined, consistent investing.
Investing is the process, not the outcome.
Too often we become fixated on the outcome without properly following the process, and ironically this hurts our chances to reach our goals. We violate the laws that govern success, and expect to still succeed.
This study on The Behaviour of Individual Investors summarizes it well:
"In theory, investors hold well-diversified portfolios and trade infrequently so as to minimize taxes and other investment costs. In practice, investors behave differently. They trade frequently and have perverse stock selection ability, incurring unnecessary investment costs and return losses. They tend to sell their winners and hold their losers, generating unnecessary tax liabilities".
The outcome we want is increasing the value of our portfolio, and yet we typically perform worse than the overall market because of our own behavior. We trade in and out of stocks when they don’t go up as fast as we want them to, we sell when the market has fallen and we’re nervous, and then we wait to invest until we know we’re not ‘catching a falling knife’. It’s a recipe for failure, or underperformance at best.
How to make investing easy
1. Find a style you can stick to
-Long-term index funds
-Long-term individual stocks
-Short-term momentum trading
2. Create a process you trust
-Automatic monthly investments
-Researching individual stock using a checklist
-Using technical analysis to identify momentum stocks
3. Commit to the process
-Focus on learning
-Make consistent action toward your process
-Don’t let the short-term outcomes steal your attention
If you focus less on the short-term outcomes and the daily swings of your portfolio and stay focused on your long-term goals and your process, you’re destined to have a successful in your investing.