How to Sleep Well Amid Uncertainty

As the market traverses present-day domestic politics, geopolitics, central bankers, corporate earnings and economics, it's incumbent upon you (the investor) and us (the investment counselors) to keep our thinking above the fray.

Recently, I analogized shooting a basketball with making investments. Since then, I've heard myself in virtually every portfolio review meeting repeating that story. I explain that this is how we sleep well at night amid all of the uncertainty (honestly, I don't recall a single moment in my nearly 33 years of consulting where the world wasn't rife with uncertainty).

In a nutshell: When good investments, not necessarily profitable investments, are consistently made over the long run, the chances of profitable results increase dramatically.

Here's a slice of that blog post (in case you missed it):

We can sum up basketball shooting as follows. There are:

1. Good shots that go in.

2. Good shots that miss. 

3. Bad shots that miss. 

4. Bad shots that go in.

#1's are great. #2's are fine, unavoidable, and possess a liveable probability rate. #3's, while costly, are the most predictable and, therefore -- being costly -- should be readily avoided. #4's -- as explained above -- are an utter curse!

Here's my point:

We can sum up investing as follows. There are:

1. Good investments that make money. 

2. Good investments that lose money. 

3. Bad investments that lose money. 

4. Bad investments that make money.

#1's are great. #2's are fine, unavoidable, and possess a liveable probability rate. #3's, while costly, are the most predictable and, therefore -- being costly -- should be readily avoided. #4's: I can't think of a worse case scenario than a new investor hitting a #4 right out of the gate. The perverse feedback from that experience could absolutely send him or her to the poorhouse -- as he or she might think that he or she's discovered a high probability investing method and chalk up the subsequent string of losses to rotten luck. I.e., believing what are in reality #3's to be #2's. The emotional imprint from that early "success" may indeed last longer than his or her capital.

In the early 1980s legendary traders Richard Dennis and William Eckhart -- having hotly debated the nature vs. nurture question for years -- made a wager. Dennis believed that great traders can become great traders through proper nurturing. Eckhart, on the other hand, believed that great traders possess the nature to be great traders. To Eckhart "either you're born with trading skills or you're not."

Not to spoil it for you if you're inclined to read the story for yourself, but based on the ultimate experience of the guinea pigs whom Dennis and Eckhart assembled and trained to settle their wager -- consisting of college grads with degrees in everything from accounting to piano music theory, as well as non-grads with vocational backgrounds such as security guard, tractor salesman, bartender, phone clerk and board game designer -- indeed, good trading can be taught.

One principal that both gentlemen agreed on, and pounded into their pupils, was:

"...when “good” trades, not necessarily profitable trades, are consistently made over the long run, the chances of profitable results increase dramatically."