Asymmetric Investment Returns - Insights into portfolio management beliefs, strategies, and tactics that aim to create a positive imbalance between risk and reward

Outcome bias is the tendency to judge a decision by its eventual outcome instead of based on the quality of the decision at the time it was made. Investors and traders often experience pain from outcome bias - as if what they know today could have been known then. Nicholas Taleb gives an interesting alternative:

One cannot judge a performance in any given field (war, politics, medicine, investments) by the results, but by the costs of the alternative (i.e., if history played out in a different way). Such substitute courses of events are called alternative histories. Clearly the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voiced only by people who fail (those who succeed attribute their success to the quality of their decision).

Nassim Nicholas Taleb, Fooled by Randomness.

This extraordinary achievement quite naturally attracts all the attention, yet close observers can say that the real secret to Yale’s remarkable success is defense, defense, defense. But how, you might ask, can defense be so important to Yale’s remarkably positive results? Starting with that great truism of longterm success in investing—if investors could just eliminate their larger losses, the good results would take care of themselves—we remind ourselves of the great advantages of staying out of trouble.

                                           -Charles Ellis, Yale Investment Committee Chairman

Pundits can come up with all kinds of complex academic sounding ways that created the impressive results of the Yale endowment, but it is pretty clear that Ellis is saying the real secret is active risk management: selling things that are going down before they become large losses. 

 

The market is not a weighing machine, on which the value of each issue is recorded by an exact impersonal mechanism, in accordance with its specific qualities. Rather, should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion. (emphasis mine).

 

Benjamin Graham (1934)