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Investment Decisions Are Not About Being Right Or Wrong

J. Patrick Collins Jr., CFP®, EA

Recently, I‘ve had a few clients comment something along the lines of, “wow, you’ve been dead right that politics shouldn’t be part of our investment decisions.  I really thought Trump might tank the markets.  I’m glad I listened to you.”  While I appreciate the comments, when I dig into them, I get a little worried.  What they are seeming to say is, “you were right, the markets went up”.  Unfortunately, that is not at all the point we were trying to make after the election last year (click here to see our comments).  If the market had gone down, my guess is those same clients could have easily said, “you idiot!  I told you we should have sold!”.  When we gave that advice a year ago, it is not based on the fact that we thought markets would go up.

Most investors seem to think of decisions as binary- you are either right or wrong.  The reality is that even if the market had gone down last year, we believe the advice we gave would have still been correct.   The correct way to make investment decisions are based on probabilities.  I hate to break it to you, but there is no such thing as a sure bet in the public markets so we must act on what gives us the highest probability of success.  Markets are very efficient so trying to outsmart them by predicting what will happen is nearly impossible to do consistently.  There is ample evidence to suggest this is the case.  The reality is that it is much better to understand the probabilities of different outcomes before you make a decision.

Why was the right decision to stay put last year?  First, the probability is that the stock market will rise.  The US Stock markets have gone up about 2 out of every 3 years of their history, so when you sell out, expecting a drop, the odds are against you.  Second, stock prices are the best reflection of value we know of.  If you sell out you are essentially saying that stock prices, which have been set by millions of buyers AND sellers, are not accurate.  Heck, we did an experiment with only 67 participants and found that groups are much better at determining price than individuals.  Imagine how hard it would be outsmart the wisdom of millions of investors?

Next time you are thinking of lightening your exposure in the market, buying an individual stock, or choosing a mutual fund that has a track record of beating the market, ask yourself what the probabilities are that those decisions will do better than just owning the market (hint- in all the examples above the probability of outperforming the broad markets are worse).  In future posts I’ll talk about what strategies have historically generated market outperformance with a fairly high probability of success.