What Are the Odds of Making a Good Investment?

Last week I stumbled upon an old Grantland article by David Hill titled: “Can’t Knock the Hustle”. [i] It is a fascinating examination of the two faces of competitive pool in the US. On one side was the traditional approach of conventional tournaments with prize money awarded to the winners (think the PGA Tour), on the other was ‘action rooms’ where the purpose of the pool matches was gambling – spectators and players would bet on the outcomes of all manner of games with a variety of handicaps applied. Although it is the same game being played, the objectives are entirely different – in one it is to find the best player, in the other to find the best odds. This distinction is important for investors. We spend much of our time trying to find the best investor, company, fund or story, and not enough time thinking about the odds.

The focus of the article was two characters. Earl ‘the Pearl’ Strickland – one of the most successful and controversial players in history (he has won over fifty major titles) – and ‘Scooter’ Goodman, a player focused on gambling and action rooms.

Although Goodman was a pool player, this wasn’t his primary skill:

“Goodman has a knack for figuring out complex odds and probabilities”.

His main enjoyment from pool was not the game itself, but in attempting to secure an advantage in agreeing the terms of the game. His edge was not in shooting pool but setting the odds in his favour.

“That’s my favourite part, the negotiating…This is where you win.”

Critically, Goodman understood that he did not need to be a great player like Strickland, he wasn’t interested in winning tournaments or climbing rankings. He just had to understand how good he was relative to the competition.

“I can play the best in the world up here if you give me enough weight”.

By “weight”, Goodman means advantages or impediments that impact the odds. This might be one player giving up all the breaks (a major impairment) or the weaker player having to pot fewer balls to win the rack. There is all manner of adjustments that can be made to transform the probabilities of the game.

While Goodman thought about little but the odds of success, as investors we are prone to neglect them. This leaves us incredibly vulnerable to making decisions where the chance of a good outcome is vanishingly small.    

Against the Odds

Why don’t investors like thinking in terms of odds? There are two reasons – because its less exciting than the alternative, which is largely storytelling, and because it is perceived as too difficult.  

Identifying a star fund manager, ten-bagger stock or the next great investment theme is far more captivating than trying to make a realistic assessment of the odds of success in that type of activity (particularly when the odds are usually terrible). When we have a compelling, narrative-led inside view, its salience means we grant it far more importance in our judgement than we should.

Calculating odds also feels like an inherently complex or even impossible task, but this is not the case. We don’t need to be spuriously accurate about the likelihood of a good outcome, just a general guide can be incredibly insightful.  

When making an investment decision, we should think about the odds of positive outcomes in two ways:

1) What are the base rates for this type of decision? This means forgetting the specifics of a situation but looking at the outcomes of a reference class of similar instances.

Let’s take an example. In 2021, Jeffrey Ptak at Morningstar wrote a timely piece looking at the subsequent performance of funds after they had returned more than 100% in a calendar year.[ii] The results were bleak – of the 123 funds that had achieved this feat since 1990, 80% went on to register losses in the three years that followed. 

This type of analysis is about creating a base rate to provide us with an outside view on a decision. When looking at a fund that has produced stratospheric returns it is very easy to be beguiled by the inevitably compelling stories that will be told about the theme and its manager. This can leave us entirely blind to the odds we are likely to be facing.  

There is no right answer on base rates, no single metric that will provide precise and accurate odds but taking this type of outside view should be integral to any investment decision.

2) How difficult is the game we are playing?  We should also spend time reflecting on the difficulty of the task we are undertaking. Imagine we are trying to forecast where ten-year treasury yields will be at the end of the year. We can carry out forensic analysis of inflation dynamics and Fed policy, but before beginning this process we should be asking – how likely is it that we are going to get the answer to such a complex question right? 

Overconfidence leads us to involve ourselves in investment activities where the sheer difficulty of the activity means that a successful result is very unlikely.



Thinking about odds and probabilities is not intuitive and often uncomfortable, but it should be essential for all investors. It is far better to be an average investor with the odds on our side, than a good investor with the odds stacked against us.  


[i] » Can’t Knock the Hustle (grantland.com)

[ii] What to Expect From Funds After They Gain 100% or More in a Year? Trouble, Mostly | Morningstar

Which Books Should Investors Interested in Behaviour Read?

Although I am clearly partial to a blog post and enjoy a good tweet or thread, few things can beat reading a great book. The beauty of a book is not just the depth in which a topic can be explored but the focus it necessitates – the physical act of buying and reading one can act as a commitment device, encouraging us to learn something new or think about something differently. Books do not make us immune to the enticement of other attractions competing for our attention, but they can add a healthy element of friction between us and the next shiny object.

I often get asked which books an investor keen to learn more about behaviour should read, and almost certainly give wildly inconsistent answers. To rectify that, here is a list of some of the books that have most influenced my thinking and are also brilliant reads. The majority of those listed are not explicitly related to behavioural finance, but they are all about how and why we make the decisions we do:

Annie Duke – ‘Thinking in Bets’: A fantastic book which not only extols the virtues of probabilistic thinking but manages to do so in an engaging and captivating fashion.

Jeffrey A. Friedman – ‘War and Chance’: Something of a hidden gem, ‘War and Chance’ is a fascinating study of decision making under conditions of uncertainty through the lens of international politics. Particularly insightful around why people are reluctant to talk in probabilistic terms.  

Tren Griffin – ‘Charlie Munger – The Complete Investor’: Nobody speaks more lucidly on investor behaviour than Charlie Munger, and Griffin does an excellent job of distilling his wisdom. Those short on time should read Munger’s speech: “The Psychology of Human Misjudgement”, which is probably the single best piece of work on investor behaviour. 

James Montier – ‘Behavioural Investing’: If my unreliable memory serves me correctly it was James Montier’s forthright and humorous writing on the vagaries and inconsistencies of investor behaviour that really got me engaged in the subject. This book is hard to get and expensive, but Montier has a ‘Little Book’ version, which incorporates some of the insight and ideas of its larger sibling.    

Daniel Crosby – ‘The Behavioral Investor’: Not only does Crosby’s book provide a great overview of how behavioural concepts interact with our investment decisions, but he also offers practical ideas about dealing with our most damaging foibles.

Daniel Kahneman – ‘Thinking Fast and Slow’: Just in case this hasn’t been read by everyone, it is worth highlighting the book that became the foundation stone for the burgeoning interest in behavioural science. No, not every study cited replicates; but yes, it is a great introduction to human behaviour and the choices we make.

Gerd Gigerenzer – ‘Risk Savvy: How to Make Good Decisions’: Gigerenzer’s work is incredibly underrated. His focus on the effectiveness of simple heuristics and decision rules to navigate complex systems is essential for investors who are constantly faced with a volatile and unpredictable environment.

Peter Bernstein – ‘Against the Gods – The Remarkable Story of Risk’: Achieves the extraordinary feat of explaining the history of risk – from Greek mythology to portfolio insurance – in an entirely fluent and engaging manner.   

Nassim Nicholas Taleb – ‘Black Swan – The Impact of the Highly Improbable’: Although the term ‘black swan’ is now widely misused, Taleb – in his own inimitable style – covers the folly of predictions, the dangers of models and the often-neglected impact of extreme events. Essential lessons for any investor.

Michael Mauboussin – “The Success Equation: Untangling Skill and Luck in Business, Sports and Investing”: No investment writer has a higher signal to noise ratio than Michael Mauboussin, his hit rate for producing distinctive and rigorous work is unsurpassed. “The Success Equation” is particularly important for investors because one of our primary failings is our inability to distinguish between luck and skill – a consistent and costly mistake.

Will Storr – ‘The Science of Storytelling’: Not obviously about investing or behaviour, Storr’s book looks at humanity’s fascination with stories and how and why they have such a profound impact on us. It is hard to think of any investment behaviour that doesn’t have a story at its heart, which makes understanding narratives essential to understanding our decisions.

Rory Sutherland – ‘Alchemy’: Aside from being very funny, Sutherland’s book challenges conventional wisdom about our behaviour and encourages counter-intuitive thinking.

Robert Cialdini – ‘Influence’: A timeless psychology book. As investors we are always being influenced or trying to influence others. Cialdini breaks this process down into six critical principles.  

Morgan Housel – ‘The Psychology of Money’: The beauty of Housel’s wildly successful book is its coupling of vivid storytelling with broad appeal. It is a book about our relationship with money but it’s not for investors, it’s for everyone. 



I have inevitably missed some personal favourites that weren’t in my mind at the time of writing and there are also those which, tantalizingly, I have not yet discovered!

What is the Point of Owning Bonds in a Rising Yield Environment?

It has been a torrid start to 2022 for bonds. Spiralling inflation has transformed the long-moribund interest rate environment and yields have risen substantially in most major markets. Not only are most bond investors nursing losses, but these losses have been registered at a time of equity market weakness. Bonds have seemingly lost their diversifying properties, produced poor returns and face into a prevailing market narrative that paints an unremittingly bleak outlook for their prospects. Given this, is it fair to question why anyone would hold bonds in this environment? No, it is not.

The unremitting negativity around bond investing reflects several major behavioural failings we face as investors – we greatly overweight the recent past, are overconfident in our ability to predict the future and struggle to accept the behavioural realities of diversification.

Rather than obsess over short-term performance and negative sentiment, it is far more important to think about the features of bond investing, the role they play in a portfolio and what recent market activity means:

– Rising yields should mean higher future returns:

The best predictor of bond returns is their starting yield. The significant rise in yields mean that future performance prospects are now brighter than they were. I would much prefer a 3% yield from a ten-year treasury (nearly) than the close to 0.5% it reached in 2020. It is incredibly common for investors’ return expectations to perversely increase as valuations become more expensive (it happens in equity markets consistently) but it is more puzzling in bonds where the interest and principal payments are contractual.*

– The chances of losing money in bonds in any given year have reduced:

Aside from those with negative yields, at the start of each year our expected return from a bond investment is positive – we will receive our coupon and roll down the yield curve (for the sake of simplicity let’s assume the curve is not inverted and there is no credit risk). The higher the yield and steeper the curve, the more yields need to rise for bonds to lose money. The considerable increase in yields means that our chances of losing money in bonds over the course of a year have reduced significantly. Higher yields give us greater protection from the threat of rising interest rates. This was detailed in this typically excellent Verdad post.

The market has the same information as us:

The concerns about the prospects for bonds – central bank rate hikes, rising inflation etc… – are generally expressed as if the market is blithely unaware of these risks. It isn’t. The behaviour of bond markets in 2022 reflect the attempt of market participants to accurately price them. What is it we know about inflation and rates that the market does not?  

Bonds represent a diverse range of security types:

Although I am guilty of discussing bonds in incredibly generic terms here, we should not forget the diverse range of securities that are encompassed by this broad definition. The features and sensitivities of floating rate notes are distinct from a treasury bond (real or nominal) as they are distinct from a CCC high yield credit.  It is important to understand both the similarities and distinct features of the various areas of the market and the specific role they might play in a portfolio.

High quality bonds are excellent diversifiers

High quality bonds are an excellent portfolio diversifier when held alongside risky assets. Despite recent returns they are likely to remain one of the most effective protections against equity market risk. No asset class works against all backdrops and in a stagflationary environment where inflation is rising and equities are weak, nominal bonds may fare poorly – but that is just a single specific scenario. In a more typical equity sell-off or economic slowdown, it is reasonable to expect higher quality bonds (particularly sovereigns) to be an effective component in a portfolio. **

Rebranding government bonds

Government bonds have something of an image problem – the common complaint is that yields are so low that there is no point in holding them compared to other asset classes (this is less true than it was a year ago). But rather than thinking about low returns, it pays to reframe their role.

High quality government bonds are typically (though not always) lowly correlated with equities, and they often make profits when equity markets suffer severe declines. This sounds like a reasonably effective portfolio diversifier and unlike a tail risk hedge there is no burn cost, in fact we get paid somewhere close to 3% (US ten year) for owning it.

From a portfolio perspective, it is critical not to focus solely on an asset’s expected return but how it behaves relative to other positions in a portfolio. The value of something that can protect value or even make money when equities are losing heavily is not simply about lower drawdowns and volatility. It is about the ability to rebalance and reallocate from your defensive asset into much more attractively valued risky assets. The compound impact of this through time can be profound.  

Of course, it is worth restating that nominal government bonds are not always a good diversifier against equities, but they often are and being paid to own those characteristics can be a compelling option from a portfolio perspective.  

The future is unpredictable and we are overconfident

Given the inflationary backdrop and recent losses, it is not surprising that sentiment around bonds seems uniformly negative. In the current environment it is incredibly easy to take strident views about the direction of yields from here (higher) and claim that owning bonds is nothing more than a wilful destruction of value. We should ignore such perspectives.

A call to give up on bonds is nothing more than an aggressive market / macro-economic forecast and we all know how successful investors are at making those. Prudent diversification is about owning assets and securities that will deliver in different market environments because the future is unknowable.

At any given moment it always feels like we are on a single inexorable path based on recent information, but that is never the case. There is always a range of potential outcomes.

Let’s map out a future scenario – inflationary pressures remain and central banks hike rates aggressively to subdue it. The rising cost of money leads to significant pressure on consumer demand and results in a recession. This is a highly stylised and simplified example but does not have a zero probability and it is an environment where exposure to high quality bonds might be valuable.

There is another scenario where inflation runs further away from central banks and bond yields must rise substantially to reflect a new reality even as equities decline. The point is we cannot know with any confidence how the economic picture will play out, nor how asset class relationships may alter.

We should make investment decisions based as much on what we don’t know, as what we think we do.



Current concerns about bonds are simply a reflection of our behavioural struggles with diversification. Diversification means that at any given point in time elements of our portfolio won’t be working, which is dissonant with our inescapable desire for everything to be performing in unison.***

If all holdings in our portfolio are successful at the same time, we should prepare ourselves for the time when they all struggle at the same time.  

Highly concentrated positioning or the abandonment of certain asset classes is little more than a reflection of dramatic overconfidence.  Either we believe in maintaining diversification, or we believe that we can predict the future.  



* It is important to remember the distinction between owning an individual bond – with set characteristics and, typically, a fixed maturity – and a bond fund which usually has an evolving set of fixed income exposures.  

** Bonds are by no means a requirement for all types of investors, but for an investor whose risk appetite would usually involve holding fixed income securities abandoning them would be nonsensical.

*** Diversification applies across asset classes and strategies, not bonds alone.


The Myth of Consistent Outperformance

There are few things the active fund management industry likes more than a tale of a manager consistently outperforming the market, year after year. It seems that there is no better sign of investment acumen than to overcome the odds and produce excess returns with unerring regularity.  The problem is that this notion is entirely spurious. Patterns of consistent outperformance are exactly what we would expect to see if results were entirely random. It is a measure that alone tells us nothing, but a belief in its significance is likely to lead us toward an array of investing mistakes.

Throughout my career there has been a fascination with hot streaks of outperformance from active fund managers. The careers of most star fund managers have been forged on seemingly rare runs of good form. Performance consistency is also often used as a tool for rating and filtering active fund managers – with skill linked to how regularly they beat their benchmarks over each year, or even each quarter or month.

Although it instinctively feels that consistent outperformance should be a marker of skill, it pays to think through the underlying assumptions that must hold for this to be true.

To think that the delivery of regular benchmark beating returns is indicative of skill we need to believe one of two things:

1) A fund manager or team can consistently predict future market conditions.

For a fund manager to outperform on a consistent basis and for us to consider it evidence of skill, then we must suppose that some individuals or teams can accurately predict the forthcoming market environment. If they cannot, then how they possibly position their portfolio to outperform through a constantly evolving backdrop?

2) Financial markets will consistently reward a certain investment style.

If we do not accept that a fund manager can predict the prevailing market backdrop each quarter or year (which we shouldn’t, because they can’t) then we must believe that a fund manager has an unimpeachable approach that always outperforms – no matter what the market conditions. It is a strategy that is impervious to cycles and styles.

It is difficult to discern which of these claims is more incredible, but if we are using performance consistency to inform our investment decisions then we are implicitly making (at least) one of them.

Stories over randomness

The overarching problem is one of narrative fallacy. We refuse to accept a randomly distributed set of performance numbers, instead we must build a compelling story to explain and justify them.

If we had a universe of 500 fund managers and each selected their portfolios based on the names of companies that they picked out of a hat we would still witness spells of consistent outperformance. We could easily create a captivating backstory about why a certain fund manager was able to beat the market with such regularity even if the results were based entirely on chance.

If there was no persistent skill or edge in active fund management (which is not an heroic assumption to make) and all results were entirely random, performance consistency would still make it appear as if skill existed.

The existence of consistent outperformers is almost certainly the result of fortune rather than skill.  

In any activity where there is a significant amount of randomness and luck in the results, outcomes alone tell us next to nothing about the presence of skill. The only way of even attempting to locate skill is by drawing a link between process and outcomes.

If we are claiming that performance consistency is evidence of skill then we must also show which part of the process leads to the delivery of such unwavering returns.  

Consistently poor behaviour

Unfortunately, the obsession with performance consistency is not just a harmless distraction, it is an issue that leads to poor outcomes for investors. There are three main problems:

1) It leaves investors holding entirely unrealistic expectations about what active funds can achieve. Consistent outperformance is unlikely to occur in the fund we own and, if it has occurred in the past, we should not expect it to persist into the future. A better rule of thumb would be if a fund has outperformed the market for five years straight then at some point it will underperform for five years straight.

2) If we buy funds following an unusually strong run of performance, we are increasing the odds of walking into expensive valuations and painful mean reversion. Rather than consistency being an indicator of skill, it is more likely to be a sign of more difficult times ahead.

3) The narratives that are weaved around consistent outperformance foster a culture of undue adulation for star fund managers. Adulation which always ends well…

Fund investors should stop focusing on and thinking about consistent excess returns – it tells us nothing meaningful – and instead concentrate on consistency of philosophy and process. In a complex, unpredictable system that is all that can be controlled.

A belief that consistent outperformance from an active fund manager is an indication of skill that is likely to persist is not only wrong, but also dangerous. Flawed expectations about the realities of active fund management inevitably lead to poor behaviours and disappointing outcomes.

All Active Investment Decisions Are About Valuation or Price

It is easy to get lost amidst a sea of ambiguous definitions when considering different investment styles and approaches. Not only can it be difficult to discern the true rationale of another investor, it might also be unclear what our own underlying motivations are for a particular decision. If we step away from the jargon however, we can see that it doesn’t need to be this complex. Virtually all active investment decisions are made for one of two reasons. Either we believe the valuation of a security is wrong or we think that the price will go up*. These are not the same thing and this distinction matters for investors.

Investors can be valuation-led or price-led.

Valuation-led investors are focused on the features of the underlying asset in which they are invested. They believe that it is mispriced relative to its fundamental attributes. They are not concerned about the behaviour of other investors.

Price-led investors do not care about the valuation of the underlying asset, they are focused on the behaviour of other investors. This is akin to a Keynesian beauty contest.

Valuation-led Investing

Berkshire Hathaway is a prime example of the valuation-led approach. Here the focus is on the robustness of the business in which they are invested, not how other investors might move the price.

It is critical to grasp the distinction between valuation-led and value investing. They are not synonymous. A value approach is just a subset of the broader church of valuation-led investing. If we invest in a security because we believe it is fundamentally mispriced, then we care about valuation.

A company might be considered undervalued because its market price doesn’t reflect its stellar earnings growth prospects, or its ability to earn and reinvest high returns on capital, or the fact that its earnings are temporarily depressed. These are all broad and distinct investment styles (growth / quality / value) that can be defined as valuation-led, but they are not all value approaches as we might broadly define it.

Price-led Investing

At the other end of the spectrum is a simple price-based trend following strategy. Here, there is no consideration of the valuation of the underlying security, it is merely seeking to exploit price patterns driven by investor behaviour.

Price-led strategies can be more of an ambiguous area. Not many investors like to say that they are investing because of what they think other investors will do or have done (apart from trend following where it is explicit). Obvious areas where price movements or the actions of other investors are paramount include thematic equities and macro strategies.

Thematic equity funds rarely launch without strong historic price momentum and the investment case often resides more on how compelling investors find the story rather than a robust fundamental case. Macro investing is often much more explicit about its intentions in attempting to decipher how other market participants will react to new developments.

Approaches which are price-led are typically incremental in nature. They are focused on how investors are currently positioned and their expected behavioural response to new information.

A Spectrum

Few things in investment are binary and most investment approaches will sit somewhere on the spectrum between valuation-led and price-led. A valuation-led investor might, for example, seek to identify a catalyst that will realise the mispricing they have identified. The foundation of the investment rationale is about the valuation of the business, but they are also attempting to understand when other investors might understand this and bring about a revaluation. Many price-led investors are interested in valuations insofar as they can draw inferences about prevailing market expectations.

Where investors sit on the spectrum is not only critical because it provides a clear insight as to why a decision is being made, but it can have significant implications for other vital aspects – most notably time horizon and risk.

Time Horizon

The shorter our investment time horizon the more likely we are to be a price-led investor. If we are basing our trades on the anticipated behaviour of other investors, then we are worried about what is happening now and tomorrow. We cannot make predictions about how investors will react in a year’s time. The purer our valuation-led approach the further our time horizon stretches into the future – we have no view on how other investors will behave, just the fundamental attributes of an asset.

The most dangerous scenario is where our environment defines what type of investor we are. We might think that we are biased towards a long-term, valuation-led approach, but if we face significant short-term pressure about results then, by default, we become a price-led investor. A disconnect between what type of investor we think we are and what our environment allows us to be is toxic.

Risk

The risks faced by investors at opposite ends of the spectrum are also distinct. Price-led investors not only have the challenge of anticipating the behaviour of others, but the stark danger of a reversal of sentiment. Market dynamics can change swiftly and sharply, and without any valuation discipline the floor can be a long way down.

The central challenge for valuation-led investors is being accurate about the fundamental mispricing in a business or asset. To make matters worse even if the analysis is correct they might be on the wrong side of investor opinion for years.

As with time horizons, a major problem arises when investors misclassify the approach they are adopting. An investor in a thematic fund who believes that they are exploiting a valuation-led opportunity could be in for a nasty surprise if the prevailing narrative shifts.

Understanding what type of investor we are (and are able to be) is absolutely paramount to making prudent and behaviourally consistent choices. If we don’t know or are mistaken, then we really have no chance of making good decisions.

* Or down, if we are short / underweight etc…

Via Negativa (What Should Fund Investors Not Do?)

As fund investors we spend a great deal of time deliberating the positive steps we can take to achieve better investment results. This is undoubtedly an important endeavour, yet there is something easier and more effective that should come first – deciding what we should not be doing.   

Nassim Nicholas Taleb highlighted the benefits of a focus on eliminating errors in his book Anti-Fragile where he describes the theological idea of via negativa, which is a means of explaining God by virtue of what it is not, rather than what it is. Taleb broadened this concept to contend that it is easier and more beneficial to stop negative activities than to attempt to identify new, constructive behaviours:

“You know what is wrong with more certainty than you know anything else.” [i]

We can eliminate the mistakes that we know are damaging and costly far more easily than discovering positive behaviours that might improve our fortunes. The more complex and unpredictable the environment, the more likely this is to be true.

This is an approach that should be adopted by fund investors, who face an unfathomable array of choices and decision points. Rather than obsessing over how to define the precise allocation to the right funds at the right time – an incredibly difficult task – it would be more productive to first concentrate on the actions we should avoid. Prioritise omission over commission.

So, what is it that fund investors should not do?

1) Don’t buy into a fund after extreme positive performance: Abnormally strong performance on the upside is highly unlikely to persist, investing after a spell of stellar returns is a horribly asymmetric bet.

2) Don’t be concentrated by fund, manager, style or asset manager: Concentration is the surest path to severe losses, it implies we know far more about the future than we actually do.

3) Don’t predict short-term market movements: We cannot predict the short-term behaviour of markets or funds that invest in them. We should not make decisions that suggest that we do.

4) Don’t check short-term fund performance: Short-term fund performance is typically nothing more than random noise, checking it frequently encourages poor decisions.

5) Don’t use performance screens: Given that strong fund performance tends to mean revert, it is hard to think of a worse way of filtering a universe of candidate funds than by ranking on the strength of historic returns.

6) Don’t keep selling underperforming funds to buy outperforming funds: A common behavioural trait which feels good at the time we do it, but compounds into a pernicious tax.

7) Don’t buy thematic funds based on strong backtests: If a fund is being launched based on an in-vogue theme with a stellar backtest the chances are we are already too late.

8) Don’t invest in active managers if we cannot bear long spells of poor performance: Even skilful active managers will underperform for long periods, if that is unpalatable invest in index funds.

9) Don’t invest in funds if you don’t understand how they make money: Investing in things we don’t understand is a recipe for disaster.

10) Don’t persist with an active manager when they start doing something different: A circle of competence for a manager is usually incredibly narrow, if they are venturing outside of this we should avoid them.

Each of these prohibitions is attempting to do the same thing – establish a simple heuristic that is generally effective in a highly uncertain environment. Although most investors prefer to embrace positive actions, putting a stop to poor behaviour is a much easier win.


[i] Taleb, N. N. (2012). Antifragile: Things that gain from disorder (Vol. 3). Random House.

Extremely Bad Decisions

There are undoubtedly countless investors nursing losses because of a choice made in recent years to abandon value-oriented strategies to fully commit to the rapidly accelerating growth bandwagon. Although the brutal reversal in the more speculative end of the growth universe can be read as a salutary lesson on style and factor rotations, it is not. It is about the dangers of making pro-cyclical decisions when returns reach extreme levels. Rather than worry about such excesses, investors willfully and gladly embrace them. We put more chips on the table as the odds of success deteriorate. *

Whilst it is impossible to precisely define ‘extreme’, our focus should be on two measures – performance and valuations.

Any investment strategy with unusually strong performance should be a cause for concern. If a reasonable expectation for excess returns from a (highly) skillful active manager is 2% per annum and a certain fund delivers 10% annualised outperformance over five years, this is not a time for adulation of a new star manager but a potential sign of a dangerous extreme. Things that cannot go on forever won’t go on forever.

There are times when performance alone can be misleading. For example, an investment fund could deliver what look to be abnormally strong results, but this might be a recovery from a tumultuous prior period. This doesn’t mean there is no risk, but it is a different type of situation. Utilising valuations in combination with past performance is the best signal for unjustifiable extremes.

Valuations can be considered in a multitude of ways but the most effective is to observe the relative valuation of a strategy or market segment through time – how expensive does it look compared to its benchmark through history? The more richly priced, the more uncomfortable we should be.

Historically strong relative performance and elevated valuations are unlikely to be sustainable and create a perilous situation where reversion or normalisation can lead to severe losses. The more extreme these measures become, the greater the risk of bad outcomes – both in terms of magnitude and likelihood.

The added problem for investors is that as returns and valuations soar, the pressure to invest will intensify. A lack of exposure to the in-vogue area will lead to painful underperformance, which will become increasingly pronounced as the trends continue. Everyone will be asking why we are not participating.

The strength of returns won’t be treated by most as a problem or a threat, but a validation of the skill of active managers in the sweet spot or proof of some new paradigm.  The more extreme the situation, the more persuasive it becomes.

If we do invest heavily into a strategy exhibiting extreme performance and valuations, we will inevitably find ourselves in the perverse situation where we have made a bad decision with the odds stacked against us, but where everyone will be congratulating us for making it. Prices become extreme for a reason – most people will be believers, and we will be viewed as having made a smart call.

It will also make us feel better. Buying in at extremes will come as a relief as we will no longer have to discuss why we’re underperforming or don’t hold enough of the fashionable areas or funds.

What happens after we invest in a strategy exhibiting extreme valuations and performance?

Well, they will continue to work for a time.  We won’t be so unlucky as to call the peak. Prevailing trends might continue to run for months and years. There will probably be sufficient time for us to take a victory lap for our decision, but the likelihood is high that at some point there will be a painful reckoning.

We cannot predict when extremes will correct. They will go on for longer than we ever expect and reach levels, which we thought were unobtainable. It is not a viable investment approach to simply sit on the sidelines and complain about the unfairness of it all.  We should, however, exhibit great caution in the decisions we make when valuations are rich and performance is remarkably strong, as this is the time where we are most vulnerable to costly mistakes that might take years or decades to recover.

This type of post is easy to write after there has been a reversal and some prior extremes have been extinguished (or at least dampened a little). Extremes are easy to spot and bemoan after the event. Yet this is about the general, not the specific. Any investment approach can be vulnerable to extremes. So how should investors deal with them?

During the excitement of extremes everyone will obsess over the inside view and be desperate to justify the returns and valuations of the current situation (this time it’s different). We should ignore this and instead focus on the outside view – what are the lessons from history about returns following similar excesses? 

When we reach extreme heights, it probably won’t matter how skillful a fund manager is, how good our research might be or how persuasive the narrative is; this will all be overwhelmed by an erratic but inescapable gravitational pull.  

If there is a sign of an extreme, we should be asking – what is the base rate for success of investing in funds or strategies with valuations and performance at these levels? How often has investing at such a time worked out well in the long-run?

The force and salience of extremes means that they can easily dominate our behaviour. The risk of investing too much, in the wrong area, at the wrong time is never greater.

Beware of extreme decision making.



* I have focused here on the risks of making pro-cyclical decisions when valuations are historically stretched and performance has been remarkably strong. The reverse of this is that there must be opportunities in being counter-cyclical at negative extremes – this is true but difficult and dangerous. It is easier to discuss what not to do, than what to do!


Why Can’t We Stop Making Short-Term Market Forecasts?

Our fascination with forecasts about short-term market movements is a puzzling trait.* Investors continue to make market predictions even though we are consistently wrongfooted. When other people make an incorrect forecast, we don’t disregard what they tell us next but instead say to them: “you were entirely wrong before, what do you think will happen next?”

This is not just a diverting human quirk; it is an incredibly damaging and costly behaviour. To save ourselves we need to stop listening to short-term market forecasts, and certainly not make them.

It is true that even the best investors make plenty of mistakes, but that doesn’t mean we should cut market forecasts some slack. There are four critical aspects, which mean that they should be readily ignored:

1) Most people are terrible at making market forecasts: The track record of market predictions is bleak. From tactical asset allocation to macro forecasting, history is littered with experts and amateurs alike who were undone by developments that they failed to anticipate. If everyone struggles to do it well, why do we pay attention to predictions, or believe that we will be the exception?

2) It is not reasonable to expect people to be good at making market forecasts: Creating accurate forecasts about a noisy, complex system is close to impossible. It is entirely fanciful to believe that anyone can consistently succeed in it.

3) Forecasts can have major consequences: Most market-related forecasts tend to be bold with severe consequences when mistaken. A fund manager being incorrect on a single stock is an entirely different proposition to a stark forecast about an impending market decline. When these predictions are wrong (which they usually are) the impact is typically harsh.

4) Market forecasts encourage poor behaviours: Forecasts about markets encourage the worst behaviours in investors such as short-termism and over-trading.  Also, if we believe that we can forecast markets it diminishes the perceived need for diversification.

Markets constantly remind us that attempting to forecast an inherently complex system is a fool’s errand yet, despite this, we cannot seem to resist it.     

Why do we keep making and listening to forecasts?

Our willingness to ignore the incontrovertible truth about market forecasts is driven by a range of factors from our own behavioural limitations to the structure of the asset management industry:

Overconfidence: Engaging in forecasting is a perfect example of how overconfidence can influence our behaviour. The trait encompasses three distinct forms: overplacement, overestimation and overprecision[i]:

Overplacement – it doesn’t matter if most people are abject at making market predictions, we place ourselves in the upper echelons. We are better than most people.  

Overestimation – we not only think we are superior to others, but we also significantly overstate our own skill and judgement.

Overprecision – we are far too certain that we have the right answer. This can be particularly damaging for investors who are prone to under-diversify and take injudicious decisions based on forecasting prowess.

Hindsight bias: Once something has happened, we cannot help but view it as an inevitable outcome. As everything becomes obvious after the fact, it feels like it was eminently predictable before it. Of course, it is not. What we witness is never inexorable, simply one path taken amongst many other possibilities. 

Incentives: Professional investors are incentivised to forecast market movements. Fees and careers depend on it. Giving clients the belief or sense that market, political and economic developments can be confidently predicted is an incredibly attractive sales pitch (even if it is an empty one).

Comfort: It is difficult living and investing in an uncertain world. Forecasts about the future give us comfort amidst chaos and unpredictability. Even though they are likely to be inaccurate, at the time they are made they make us feel better.

Fooled by randomness / survivorship bias:  If we have a large group of people making market forecasts then inevitably there will be some who are correct; this would be the case even if everyone was making guesses at random. That there are always some people who have called it right makes us believe that it is possible – “somebody got it right, why didn’t we?”. The mistake we make is to assume that some successful forecasts within a group at one point in time (the survivors) means that certain individuals can consistently make good predictions through time.

False Expectations: There is an expectation that investors should have an opinion about ‘markets’ and saying “we don’t know” is incredibly difficult to do (and generally not a good career move). The default is to have a view even when we know that it is likely to be unfounded.  

Despite it undeniably being a loser’s game, it is far easier to make predictions about markets than not. Part of the reason it remains such an ingrained feature of the industry is that most participants are more willing to keep playing the lucrative game, rather than take the more difficult path of realism and education. 

Why Do We Learn the Wrong Lessons?

Given that our forecasts and predictions are consistently mistaken it would seem we have ample opportunity to realise the error of our ways, but we don’t take these. Instead, we learn the wrong lesson over and over again. Whenever we are blindsided by an event or occurrence our tendency is to review what happened and ask – what did we miss? Or – how can we adapt our approach to make better forecasts in the future?

This type of reflection seems sensible but is far from it. The lesson that we should learn (but never do) is that short-term movements in financial markets (and everything related to them) are far too difficult to accurately predict, and we should stop attempting to do it. We need to make our investment decisions on the basis that we cannot forecast most things, not that we can.

But perhaps this statement is too definitive, there are better approaches to forecasting. So, should investors try to improve before abandoning the activity altogether?

Can Investors Superforecast Markets?

Philip Tetlock’s work on superforecasting has risen to prominence in recent years and given credence to the idea that although forecasting is generally done poorly, there are certain individuals that can consistently beat the average and experts. 

Although superforecasting is often framed as a group of particularly skilled and well-calibrated people; the real lessons are in how they make their forecasts and why this leads to better results.[ii] 

The key tenets of superforecasting include an ability to make probabilistic judgements (which allow for the expression of uncertainty), an awareness of base rates (appreciating the odds) and Bayesian updating (adjusting probabilities based on new information). If we are going to indulge in market forecasts, these should be central pillars of our approach. Despite the evidence that forecasting can be improved however, when it comes to markets investors should still avoid it.

Even if we take proven steps to enhance our forecasting abilities the challenge for investors remains too great. Financial market predictions are an exercise in extreme complexity. Not only are we attempting to anticipate how certain issues and events will unfold (known unknowns), but any market forecast will also be implicitly incorporating situations that have not yet occurred (unknown unknowns). To make matters worse, our market predictions are always about second order effects. Projections about how investors in aggregate (the market) will react to other developments. Superforecasting might help a little, but it is nowhere near sufficient to solve something quite so problematic and noisy.

Superforecasting extols the benefits of combining a probabilistic approach with Bayesian updating. This means when we receive new information, the odds should shift based on our assessment of its implications. Although undoubtedly a better approach to forecasting, it is hard to see how investors could realistically implement such an approach. Not only is it a herculean task to correctly judge information and ascribe probabilities, but these would somehow need to be converted into positions and trades. Critically, the inherent uncertainty in financial markets also means that frequent adjustments would be required resulting in high turnover and trading costs. It is simply not feasible.

Predictions about the future are sometimes inescapable and where investors must make them, we can seek to learn from the success of the superforecasters. Unfortunately, however, there is no magic formula to anticipating the short-term fluctuations of financial markets.

One of the problems of market forecasts is that they are so easy to make. That they can glibly roll off the tongue, belies how fiendishly complicated the activity is. When we see or hear one, it is worth taking a step back and thinking through exactly what foresight is being claimed and quite how absurd it is to believe that anyone possesses it.


* It is difficult to precisely define what short-term is, but the shorter the horizon and the greater the specificity in a forecast the more problematic it is likely to be. Forecasting that equity returns will be positive on a twenty-year view, is an entirely different proposition to predicting how the Chinese A Share market might perform over the next six months. Anything inside one year is incontrovertibly very short-term.

I have written about how and when we should make forecasts here.


[i] Moore, D. A., & Schatz, D. (2017). The three faces of overconfidence. Social and Personality Psychology Compass11(8), e12331.

[ii] https://goodjudgment.com/philip-tetlocks-10-commandments-of-superforecasting/

There Has Never Been a Better or Worse Time to Be an Investor

Investors have never had it so good. We have unprecedented choice, improved transparency and easy access to valuable information. All this with ever-decreasing fees. Yet to believe that these are halcyon days ignores the behavioural reality. Many of the benefits that investors now enjoy come with significant behavioural costs that threaten to turn the best of times into the worst of times.

Let’s begin by looking at the main areas where investors now seem unequivocally better off:

Cost: The cost of investing in simple funds and strategies aligned to our long-term objectives continues to fall.

Control: Improved technology means that we can now select and change our investments at will. No longer are we condemned to persist with unsuitable holdings or thwarted by a quagmire of unfathomable paperwork.

Transparency: We can see exactly what is happening in our portfolios whenever and wherever we wish.

Choice: There is easy access to the full gamut of investment strategies, no matter what our requirements or preferences.

Information: Many high-quality investment insights are freely available.

So far, so good. Yet if we consider the same categories through a behavioural lens, a different picture emerges:

Cost: How can low costs be bad for investors? When they are used as a tool to lure us into activities that we should never engage in. Commission free or low cost trading in individual stocks, FX and even esoteric options comes at a punitively high cost for investors not simply because of the spreads, but the losses we will register with grim inevitability. There are scores of studies looking at the poor results of individual investors trading in such a fashion. Even the adverts for companies providing these services tell us just how bad we are in the small print.

Low costs here are not a benefit, just a hook to turn us into committed, unsuccessful gamblers.

Control: Closely aligned with transparency is the purported benefit of control. We don’t only see our investments each day, we can trade them too. Unfettered control means there is no protection against poor system one or hot state decisions. We make choices that make us feel better in the moment but come with a heavy long-term cost.

From a behavioural perspective, the combination of transparency and control can be toxic.

Transparency: It is difficult to argue that better transparency is a negative for investors, of course it is not. We must, however, be aware of the behavioural implications of improved visibility. The more frequently we observe our investments, the more likely we are to be captured by myopic loss aversion. Where our struggle to cope with short-term losses provokes poor decisions.

It is hard to think of a greater impediment to good long-term outcomes than being able to check our portfolios every day.

Choice: The vast array of choice available to investors is a curse rather than a blessing. Not only will we be confused by the complexity of options, but we will also never be satisfied. The paradox of choice means that we will be constantly frustrated by our failure to select the best option.

Too much choice can easily lead us to feeling confused and unhappy.

Information: We certainly have access to good quality information and guidance, but investors must also suffer a torrent of misinformation and noise.  From financial news channels counting down the seconds to each day’s market to open, to trading experts on Twitter (selectively) highlighting their otherworldly acumen; the weight of unhelpful information vastly outweighs that which is sensible. Brandolini’s law that “the amount of energy needed to refute bullshit is an order of magnitude bigger than is needed to produce it’, certainly applies to the investment information now easily available to us.

The problem of noise and misinformation is exacerbated by the fact that good investment guidance is boring, and the nonsense often far more interesting.  



I often wonder who is better off. An unengaged investor who owns an underwhelming and unduly expensive active global equity fund in their pension but leaves it untouched over the years; or a fully engaged investor who assiduously checks their portfolio and trades actively. Whilst neither is ideal, the first investor will probably have superior outcomes because their ignorance insulates them from many of the sternest behavioural challenges we face.  

It is far too easy to ignore or understate the true consequences and costs of poor investment behaviour.

So, is now the best or worst time to be an investor?  Probably both. Like never before, investors have the opportunity to make simple and sensible decisions that deliver on their long-term goals. Yet this ignores the stark behavioural realities that we face. From a behavioural perspective it has never been more difficult to make good investment decisions, and unless we attempt to manage this it might really be the worst time to be an investor.

Most Investors Should Ignore the Risk of Major Macro Events

The Russian army’s intimidating presence on the border with Ukraine is the latest macro event that has investors concerned about equity markets. It is also the latest macro event that most investors would do well to ignore*.  We worry about specific, prominent issues because we want to protect against the losses that may occur if our worst fears are realised. The irony is the most sure-fire way for investors to make consistent and substantial losses is by lurching from one high profile risk to the next, making consistently poor decisions along the way. 

We have all seen the charts extolling the virtues of taking a long-term approach to equity investing.  They show how markets have produced strong returns in-spite of wars, recessions, and pandemics. They are a great illustration of the benefits of a long-term approach, but they don’t tell us everything.

What they fail to show is all those critical issues that worried investors but never came to pass. We are always confronting the next great risk to markets; the key to successful investing is finding ways of drowning out this noise.

There are two key reasons why this is incredibly hard to do:

First is how the media and industry serve to stoke rather than quell damaging behavioural impulses by obsessing over the latest macro risk. It’s far more interesting to speculate over the potentially dramatic implications of a given situation, than to repeat some boring lessons about sensible investor behaviour.

Second is that because some events have mattered in the past and some will matter in the future, we feel compelled to act on everything – just in case the current issue really does have an impact. Imagine if disaster strikes after we told everyone to disregard the risk.

Even though we can be certain that there are some events that will cause dramatic (short-term) losses for risky assets; discounting them is absolutely the best course of action for most long-term investors. This is for a host of reasons:

We cannot predict future events: Pre-emptively acting to deal with prominent risks that pose a threat to our portfolios requires us to make accurate forecasts about the future. Something that humans are notoriously terrible at.

We don’t know how markets will respond: We don’t only need to forecast a particular event; we also need to understand how markets will react to it. What is in the price? How will investors in aggregate react? Even if we get lucky on point one, there is no guarantee we will accurately anticipate the financial market consequences.  Take the coronavirus pandemic – if at the start of 2020 we had been able to see into the future and look at the economic data for the year ahead, we would have almost certainly made a host of terrible investment decisions. In investing, even foresight might not be enough to save us from ourselves.



It is worth pausing to reflect on these first two reasons. Forecasting events and their impact on markets is an unfathomably complex problem to solve. We are incredibly unlikely to succeed in it.

2016 is useful example of this problem. For both the US election and Brexit (two macro risk obsessions at the time) investors were wrong footed by both elements – the forecast of the votes (even though they were binary) and the market reaction to them. Years and months were spent pontificating over positioning for those events, and many very intelligent people got everything wrong.   

When questions are posed such as: “What are you doing in your portfolio about Russia / Ukraine?” It is useful to unpack what is really being asked here, which is: “With limited information and a huge degree of uncertainty and complexity, have you made an accurate assessment of the likely outcome of the tense political / military stand-off between two countries, and then judged the market’s reaction?”

The answer should be no.

If the answer is yes, then we are displaying a huge degree of overconfidence.  



We are poor at assessing high profile risks: We tend to judge risks not by how likely they are to come to pass, but how salient they are. This a real problem for macro events because the attention they receive makes them inescapable, so we greatly overweight their importance in our thinking and decision making. This is why the media and industry focus on them is so problematic – it makes us believe that risks are both more severe and more likely to come to fruition.  

We need to be consistently right: Even if we strike lucky and are correct in adjusting our portfolio for a particular event, that’s not enough – we need to keep being right. Making a bold and correct investment decision about a single event is one thing, but what about the next one that comes along? We need to make a judgement on that too, we can’t undo all our prior good work. Over the long-run being right about any individual prominent macro event is probably more dangerous than being wrong, because it will embolden us to do it again. 

Most events will not matter to our long-term returns: Daniel Kahneman’s comment that “nothing in life is as important as you think it is, when you are thinking about it” could be used in relation to short-term events and our long-term outcomes. In the moment that we are experiencing them macro events can feel overwhelming and all-encompassing, but on a long-term view they are likely to fade into insignificance.   

It is not that macro events are never significant for markets. There will be incidents in the future that will lead to savage losses in equities; we just won’t be able to predict what will cause them or when they will happen. Trying to anticipate when they will occur, rather than accepting them as an expected feature of long-term investing, will inevitably lead to worse outcomes. 

If we find ourselves consistently worried about the next major risk that threatens markets, there are four steps we should take:

1) Reset our expectations: Investing in risky assets means that we will experience periods of severe drawdown. These are not something we can avoid, they are an inevitability. They are the reason why the returns of higher risk assets should be superior over time. We cannot have the long-term rewards without bearing the short-term costs. We need to have realistic expectations from the start.

2) Check we are holding the right investments: The caveat to ignoring the risks of major macro events is that we are sensibly invested in a manner that is consistent with our long-term objectives. If we have 100% of our portfolio in Russian equities, it might make sense to be a little anxious about recent developments. The more vulnerable our investments are to a single event, the more likely it is we have made some imprudent decisions.    

3) Engage less with financial markets and news: There is no better way to insulate ourselves from short-term market noise and become a better long-term investor than to disengage from financial markets. Stop checking our portfolio so frequently and switch off the financial news. 

4) Educate ourselves about behaviour, not macro and markets: What really matters to investors is not the latest macro event or recent markets moves, but the quality of our behaviour and decision making. We need to shift our focus. The asset management industry can do a lot to help here because at present it does little but promote noise and unnecessary action, inflaming our worst behavioural tendencies.



Provided we are appropriately diversified, the real investment risk stemming from major macro events is not the issue itself but our behavioural response to it – the injudicious decisions we are likely to make because of the fears we hold.

We need to find a way of worrying less about markets and more about ourselves.



* As I hope is obvious, this observation is purely from an investment decision making perspective. Macro events will often have profound human consequences, which we should absolutely not disregard.