The former World Series of Poker champion, and now corporate consultant, Annie Duke, has written a wonderful book on decision making titled “Thinking in Bets, Making Smarter Decisions When You Don’t Have All The Facts.”
The book opens with a story that many football fans have said is the worst play call in Super Bowl history.
For those that may not remember, the Seattle Seahawks were down by 4 points with 26 seconds left in the game with the ball on the one-yard line. The head coach of the Seattle Seahawks, Pete Carroll, called a pass play instead of handing off the ball to one of the best running backs in the NFL. The pass was intercepted and the New England Patriots won the Super Bowl.
When the details of the situation are clearly discussed in the book — the number of downs and time outs left, along with the fact that not one of the sixty-six passes attempted from the one-yard line that season were intercepted (only 2% of such passes in the last 15 years!) — the decision to the throw seems to make much more sense.
If the play worked, Carroll would have been praised for his great decision. Consequently, if it didn’t, he would have been widely criticized. As many of us know now, he became a victim of our tendency to equate the quality of a decision with its outcome.
Poker players call this “resulting.” Veteran poker players recognize this effect and resist the temptation to change their strategy if they have a few bad hands.
Why is this important to an investor? Because, as Duke points out, “resulting,” and other human cognitive errors, lead right into the world of Behavioral Economics.
To start, the human brain has evolved to create certainty and order. We do not like to think that chance plays a part in outcomes. Humans have survived because they have made order out of chaos. Our brains evolved to do this — to seek certainty. Uncertainty wreaks havoc on our brain and emotions!
Wall Street has recognized this human need for decades. Wall Street marketing wants us to believe that investing is like chess. In chess there is certainty — a correct answer for every move. It may not be known by a player during a game, but it exists. Wall Street firms produce volumes of data every day in an effort to make investors think they know the future, that they create certainty out of chaos. Many investors love this stuff! It feeds their need for order. The problem is, however, that evidence shows the Wall Street prognosticators are consistently inaccurate. To quote John Bogle, the late founder of Vanguard, “Nobody Knows Nothing.”
If an all-knowing investing algorithm existed, we would already be plugged into it.
In reality, investing is more like poker. As Duke says:
“Poker…. is a game of incomplete information. It is a game of decision-making under conditions of uncertainty over time …valuable information remains hidden. There is also an element of luck in any outcome. You could make the best possible decision at every point and still lose the hand.”
So what does this mean for the average person trying to save for retirement or live off of their savings?
To start, an investor needs to understand that the volatility of the markets are attacks on their need for order. There have been over one hundred behavioral biases scientifically documented to date.
After that, an investor should base their decisions on a model that will give them the best probability of success. To do this an investor should do the following:
- Start with a financial plan; one should know what they want to achieve in order to properly build a strategy.
- Gain an understanding of how comfortable you are with market volatility (risk tolerance).
- Base your investing decisions on the plan and your risk tolerance.
- Base the investing decisions on what evidence and academic research has shown to work over many market cycles.
- Understand that your brain will scream to you to protect yourself during volatile times; when markets tumble your protective instinct is to sell. Your brain is often not your friend during times of stress.
- Use an advisor the will help you build the plan, who knows your risk tolerances, who knows behavioral tendencies of investors, who knows market history, who has studied portfolio theory and the evidence that supports it.
- Use an advisor who will tell you to stay the course when you want to join the madness of the mob and change your strategy.
The above points will lead to a good decision process. This is the best you can do in an uncertain world. This is how the best poker players succeed. They have good decision processes. They don’t win every hand; that is impossible. But, over time, they win the most money. They don’t let “resulting” effect their long term goals.
To paraphrase Duke: In the end, the quality of our financial lives will be the sum of decision quality plus luck.
An investor will improve their chances by partnering with an advisor who will help increase the quality of their decisions and help them push against their tendency to get into a resulting mindset and stay true to their strategy.
As for the element of luck, in the words of Louis Pasteur, “Luck favors the prepared!”
Michael Angelucci, MBA, CFP®