Never Judge a Decision by Its Outcome: Outcome Bias
A quick hypothesis: Say one million monkeys speculate on the stock market. They buy and sell stocks like crazy and, of course, completely at random. What happens? After one week, about half of the monkeys will have made a profit and the other half a loss. The ones that made a profit can stay; the ones that made a loss you send home. In the second week, one half of the monkeys will still be riding high, while the other half will have made a loss and are sent home.
And so on.
After ten weeks, about one thousand monkeys will be left—those who have always invested their money well. After twenty weeks, just one monkey will remain—this one always, without fail, chose the right stocks and is now a billionaire.
Let’s call him the success monkey.
How does the media react?
It will pounce on this animal to understand its “success principles.” And they will find some: Perhaps the monkey eats more bananas than the others. Perhaps he sits in another corner of the cage. Or maybe he swings headlong through the branches, or he takes long, reflective pauses while grooming. He must have some recipe for success, right?
How else could he perform so brilliantly? Spot-on for two years—and that from a simple monkey? Impossible!
The monkey story illustrates the outcome bias: We tend to evaluate decisions based on the result rather than on the decision process. This fallacy is also known as the “historian error.”
A classic example is the Japanese attack on Pearl Harbor. Should the military base have been evacuated or not? From today’s perspective: obviously, for there was plenty of evidence that an attack was imminent. However, only in retrospect do the signals appear so clear. At the time, in 1941, there was a plethora of contradictory signals. Some pointed to an attack; others did not. To assess the quality of the decision, we must use the information available at the time, filtering out everything we know about it post attack (particularly that it did indeed take place).
Another experiment: You must evaluate the performance of three heart surgeons. To do this, you ask each to carry out a difficult operation five times. Over the years, the probability of dying from these procedures has stabilized at 20 percent. With surgeon A, no one dies.
With surgeon B, one patient dies.
With surgeon C, two die. How do you rate the performances of A, B, and C?
If you think like most people, you rate A the best, B the second best, and C the worst. And thus you’ve just fallen for the outcome bias.
You can guess why: The samples are too small, rendering the results meaningless. You can only really judge a surgeon if you know something about the field, and then carefully monitor the preparation and execution of the operation. In other words, you assess the process and not the result.
Alternatively, you could employ a larger sample: one hundred or one thousand operations if you have enough patients who need this particular operation. For now it is enough to know that, with an average surgeon, there is a 33 percent chance that no one will die, a 41 percent chance that one person will die, and a 20 percent chance that two people will die. That’s a simple probability calculation. What stands out: There is no huge difference between zero dead and two dead. To assess the three surgeons purely on the basis of the outcomes would be not only negligent, but also unethical.
In conclusion: Never judge a decision purely by its result, especially when randomness and “external factors” play a role.
A bad result does not automatically indicate a bad decision and vice versa. So rather than tearing your hair out about a wrong decision, or applauding yourself for one that may have only coincidentally led to success, remember why you chose what you did.
Were your reasons rational and understandable?
Then you would do well to stick with that method, even if you didn’t strike it lucky last time.
* Source: The Art of Thinking Clearly by Rolf Dobelli
More reading on Outcome Bias here at : https://hbr.org/2016/09/what-we-miss-when-we-judge-a-decision-by-the-outcome
Highlights of Union Budget 2017 – 2018
GST – No changes in service tax & excise duty as GST draft will be launching soon
Fiscal Deficit – Seen at 3.2% (17-18) & 3% (18-19)
Current Account Deficit – 0.3% (16-17) 1st Half
FDI Investments – 1.45 Lakh Crores (16-17) 1st Half
Direct Tax – Tax to GDP Ratio is very low
Income upto 2.5 Lakhs – Nil Tax
Income above 2.51 Lakhs to 5 Lakhs – Reduces to 5% Tax from 10%
Income above 50 Lakhs to 1 Crore – 10% surcharge
Farmer – Double their income in 5 years
Agriculture – 10 Lac Crores credit
MNREGA – Allocation 48,000 Crores
PM Gram Sadak Yojna – Allocation 19,000 Crores
Sr. Citizen – 8% guaranteed pension for 10yrs by LIC of India scheme
James Montier, a favourite among the readers of value investing, produced a white paper in March 2011, entitled “The Seven Immutable Laws of Investing”. In the paper he presented a set of laws to guide investors towards investing sensibly in stock markets.
“In my previous missive I concluded that investors should stay true to the principles that have always guided (and should always guide) sensible investment, but I left readers hanging as to what I believe those principles might actually be. So, now, for the moment of truth, I present a set of principles that together form what I call The Seven Immutable Laws of Investing.” ~ James Montier.
They are as follows:
1. Always insist on a margin of safety
2. This time is never different
3. Be patient and wait for the fat pitch
4. Be contrarian
5. Risk is the permanent loss of capital, never a number
6. Be leery of leverage
7. Never invest in something you don’t understand”
Here is the complete text : The Seven Immutable Laws of Investing ….. By James Montier
“All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don’t work out” ~ Peter Lynch ~ One up on Wall Street.
I have been reading ‘One up on Wall Street’ ~ Peter Lynch. The book is a classic and a must read for people interested in value investing.
This Part III is in continuation to earlier parts and thus completes the twelve most silliest things people say about stock prices as mentioned in the book.
I hope this trilogy will help you in your investing journey.
Thank you Peter Lynch for the wonderful book and common sensical approach to stock investing. Enjoy (points 9 through 12)….
9. What me worry, Conservative Stocks do not fluctuate much…
Peter Lynch gives examples of Utility Companies. Two generations of investors grew up on the idea that they could not go wrong with the Utility stocks. You could just put them in safety deposit and cash the dividend checks. However with the nuclear and the base rate problems, suddenly the nuclear plants became expensive and stocks fluctuated wildly over a couple of years.
Companies are dynamic and prospects change. There simply isn’t a stock that you can own and you can afford to ignore.
Near home, FMCG Stocks have always been considered conservative stocks with relatively low beta and good dividends. However, over the past 2 years most of the FMCG stocks have considerably outperformed the index. The valuations are stretched and stocks have literally become multi baggers. Can these stocks be considered be conservative any longer? Is anybody’s guess….
10. It’s taking too long for anything to happen
“PostDivesture Flourish”, a term coined by Peter Lynch, which means that after considerably waiting for a stock to do something, you give up, and when you finally sell the stock, the price of the stock starts to flourish and move northwards.
I have experienced this when I gave up on LIC Housing Finance in mid 2009 after holding the stock for almost 3 years. The stock went up almost 5 times in the next 2 years.
Learning ~ Do not give up on the stock if all is well with the company and the reasons for which I bought the stock have not changed.
The stock markets tests patience and rewards conviction.
It takes remarkable patience to hold on to an idea / stock that excites you, but which the market largely ignores. You begin to think everyone else is right, and you are wrong. But remember, where the fundamentals are promising, patience is more often than not ~ rewarded.
11. I missed that one, I will catch the next one
This is such a common mistake committed by a large number of investors.
Page Industries is one such stock, which has given phenomenal returns to investors over the past 3 years, and continues to do so. Investors who missed out on Page Industries are trying to catch onto other seemingly similar stocks like Lovable Lingerie.
This is a mistake because the performance of Page Industries is based on various factors like the company management, capital structure, earnings growth, streamlined and strategic supply chain, brand image, brand power and brand recall value, customer loyalty, vendor relationships, pricing power etc which is difficult for another company to imitate. The other company should be judged on it’s own merit for investment purposes.
It’s always better to buy the original good company at a higher price than to jump on to the next one at a bargain price. (Same logic applies when buying real estate as well…. I will talk about my views on real estate some other time though…)
12. The stock’s gone up, so I must be right or Vice Versa.
Peter Lynch terms this as the single greatest fallacy of investing. Believing that when the stock price is up, then you’ve made a good investment. Investors confuse prices with prospects.
If you purchase a stock at Rs 100 and it moves up to Rs 105, investors take comfort from this fact, as if it proves the wisdom of their purchase. Nothing could be further from truth. Investors commit mistakes based on this fallacy ~ Either selling a good company at a loss, believing that they committed a mistake or holding on to bad apples if the prices are up post the purchase.
Remember the Stock does not know that you own it.
Unless you are a short term trade looking for 20 odd % gains /loss the short-term fanfare means absolutely nothing.
A stocks going up or down after you buy only indicates that there was someone who was willing to pay more or less for the identical merchandise. That’s it
With this I lay to rest the 12 mistakes committed by investors with the hopes that you, can avoid these common mistakes and in the process become a successful investor.
The Golden Rules of Investing are essentially a common sensical approach which largely comes down to the emotional aspects such as Discipline, Patience, Greed & Fear.
Remember these 10 golden rules of Investing.
1. Risk is inevitable – What is Risk? Understanding Risk is the first part and then learning to Manage it.
2. Start early – Benefit from compounding. Einstein has acknowledged Compounding as the 8th wonder of the world.
3. Have realistic expectations – Greed is bad. How much is too much. You never know what is enough, until you know what is more than enough.
4. Invest regularly – Not even God can time the markets. Timing/Forecasting the markets is an illusion.
5. Stay Invested – Be a marathon runner. Markets tests patience and rewards conviction.
6. Don’t churn your investments – It only increases costs. If you like gambling, go to a casino. For serious investing, stay put.
7. Spread your corpus – Each investment class is important. Don’t put all your eggs in one basket.
8. Sell your losers – Hope doesn’t make money, Wisdom does. We are biased against actions that lead to regret. People attach too much weight to gains and losses rather than wealth.
9. Hot tips usually burn your investments – Avoid them. Remember the reverse of TIP is PIT. So a tip usually dumps you in a PIT almost always.
10. Taxes are important – But not at the cost of a bad investment. Only Death and Taxes are certain, true ~ But don’t make bad investments just to save tax. Don’t be Penny Wise Pound Foolish.
Martin Seligman author of ‘Authentic Happiness’ and research psychologist has said that there are three parts to happiness : Pleasures, Engagement and Meaning.
Pleasure is the feel good part, the short term happiness of material possessions in life.
Engagement refers to good life involving work, friends, family and hobbies.
Meaning is using our time and strengths towards a larger purpose.
He reckons, that Although all the three are important , it is the last two which make a significant difference.
Now a lot of time we spend goes into increasing or earning money. Hence it is worth figuring out where money and hence financial freedom comes into play in our overall happiness.
Does Higher Income really lead to Happiness though? Is the million dollar question.
When researched , the results are surprising. ? A study from Princeton University found that a larger paycheck does lead to a happier life—but only to a certain point. ($75,000 per annum to be precise)
What really affects our happiness more than how much we make is our attitude toward money and the way that we handle it. When we hold fast to the belief that money directly determines happiness, life becomes a constant pursuit of accumulating ”more”.
Would winning a lottery make us the happiest people on earth? Harvard Psychologist Dan Gilbert says NO.
He goes on to prove that we human beings are very good at adapting but extremely poor in predicting when it comes to our emotions and feelings. We tend to overestimate the duration and intensity of our future emotions.
For eg: A dream home with all modern amenities couple of extra bedrooms, with a beautiful view gives pleasure for a few months. Before the purchase, we tend to think that the possession will provide everlasting happiness and also experience that the happiness will be the ultimate satisfaction. But the same disappears later. At times it can also possibly have a negative effect on happiness at times.
Even when you change jobs or progress in career he has found out across subjects that in approximately 3 months they are back in the same place in terms of happiness. You can extend the examples to Car , let’s say you buy a porche or a BMW , the impact is the same.
This is one of the most important research subject in behavorial finance. Known as Hedonic treadmill. We work hard, earn more, and are indeed able to afford better and nicer things and yet it dosen’t make us any happier. The deeds and things you worked so hard for no longer make you happy; you need to get something even better to boost your level of happiness.”
Wouldn’t it be better if we knew exactly how happy a new car, career, house or relationship would make us? It is quite possible if we do the following :
Avoid negative things that you cannot get accustomed to such as commuting , noise, chronic stress
Expect only short term happiness from material things such as cars, houses, lottery tickets, prizes, bonuses.
Accept your present
Aim for as much free time and autonomy as possible since long lasting happiness comes from what you actively do
Follow your passions even if you have to forfeit a portion of your income for them
Invest in friendships
Finally, Understand your relationship with Money. Don’t let money control your life . Rather Get a control over Money.
Have clear financial goals, focus on purchasing assets (rather than accumulating liabilities) and make your assets work along with you in order to achieve those goals. Remember, assets is something which puts money in your pockets, where as liabilities is something which takes money out of your pockets.
This independence day resolve to achieve financially freedom in your life.
Life is inherently risky. There is only one big risk you should avoid at all costs, and that is the risk of doing nothing… Applies to life and investments as well…