Daniel Bernoulli of the Bernoulli effect fame, discovered when trying to solve the St. Petersburg Paradox that a person takes risks not only based on the expected gains or losses but also on the utility of the action itself. In other words, an action with a high chance of making $100,000 may not be worth the trouble for Warren Buffett but can be a great investment for an average person.
Conversely, a good investment for Warren Buffett is not necessarily a good investment for you. Warren Buffett invests on behalf of his corporation which has a perpetual timeframe whereas you have to plan for goals with finite timelines. And a billionaire can lose 90% of her wealth and still have a hundred million dollars left. You won’t.
You are playing a different game — your own game. It is you against your goals. You don’t need to beat the market. You don’t need to beat your neighbor. You can’t have FOMO or you end up buying high and selling low — a true disaster.
The key is to focus on the process and to know that good outcomes follow good processes. Without understanding the process, good outcomes could just be dumb luck as opposed to skill.
You should remind yourself about this every time you read this disclaimer “past performance is no guarantee of future results”. What this disclaimer is actually doing is admitting that market outcomes are largely random. When past performance is the result of luck, it then provides zero insights into what the future may hold.
You can’t always isolate the factors that bring about good outcomes, but you can always trust what a good process delivers. It may not guarantee a win every single time but it does stack the deck heavily in your favor.
The goal of a portfolio should be to earn your required rate of return with as little risk as possible. Gambling on high risk investments to get richer isn’t a risk worth taking unless you already have more than enough. It is okay to sin a little then assuming it does not jeopardize the core of your plan.
You also want to control the controllable. It is a waste of energy trying to forecast interest rates or election outcomes or the next market swings, all outside of your control. What remains in your control are things that are more modest yet powerful — how much you save, how you allocate your savings between investments, how efficiently you manage your taxes and whether you’ll stay emotionally disciplined when markets turn frightening.
Long term success has more to do with mastering these controllable variables than with any gift of prediction.
And comparison is a constant temptation that can corrode the best of plans. A financial plan built around your neighbor’s vacation or a friend’s home renovation or a colleague’s investment returns has the wrong foundation. It incites you into overspending and speculative decision making you would otherwise never make if you simply asked what your own life requires.
You have to tend to your own garden. Overspending, chronic undersaving or speculative trading cannot be overcome with willpower alone. It requires a concrete plan backed by a good process, accountability and guidance of a trusted advisor.
Thank you for your time.
Cover image credit – Made These, Pexels