Barry Ritholtz: Outcome or process — what investment focus succeeds over time?

Barry Ritholtz
Columnist February 22

“The reason investors and the investment industry rely on performance is because it’s simple, objective and easy to measure. But more importantly, performance goals, performance reviews and performance measurement are so common in business, in sports, in education, in investing — almost everywhere — that not using them feels uncomfortable.” — Marshall Jaffe, Think Advisor

Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. View Archive

Has this ever happened to you?

In the course of a conversation, you learn about an acquaintance or colleague who made an unusually successful investment. For whatever reason, they put capital at risk into XYZ and the returns were extraordinary — far more than what is typical for your investment returns.

In that situation, which of the following comes closest to your immediate thoughts?

(1) I wish my 401(k) was filled with XYZ !

(2) If only I had his access to his inside information.

(3) How much time and effort goes into his research?

(4) What does his win/loss ratio look like? Gains vs. losses over time?

(5) Sounds like he got really lucky.

If your thoughts were along the lines of answers 1 or 2, you are, like most investors, outcome-focused. If your thoughts were along the lines of answers 3 or 4, you are in the minority, and are process-focused. Answer 5 can fall into both camps, but the significance of each depends on the context.

Let’s define these two so you have a better sense of what is under discussion.

Outcome is simply the final score: Who won the game; what numbers came up in a roll of the dice; how high did a stock go. Outcome is the result, regardless of the method used to achieve it. It is not controllable. You can blow on the dice all you want, but whether they come up “seven” is still a function of random luck.

Process, on the other hand, is a specific methodology. It is a repeatable approach to any challenge or endeavor, be it construction or medicine or investing. And you can control a process.

What kind of people are outcome-oriented? Gamblers, many (but not all) sports fans and, of course, speculators.

What about the process-oriented people? They include airline pilots, professional sports coaches and, of course, long-term investors.

I have never recommended a sports book in these pages – how relevant are they for investors? – but I am going to do so now: New York Giants Coach Tom Coughlin’s book “Earn the Right to Win: How Success in Any Field Starts with Superior Preparation.” Coughlin is a master of process. His approach to football is rigorous and data-driven. His players enter each game better prepared than the opposing team. Imagine what a huge psychological advantage it is, knowing you know much more about your opponents than they do about you.

For example, the annual NFL Scouting Combine is a week-long showcase for head coaches and assistants to look over this year’s draft prospects. Clipboards in hand, they prowl events evaluating more than 300 players.

Before he joined the Giants, Coughlin was fired after nine seasons with the Jacksonville Jaguars. That small inconvenience did not keep him from pursuing his process, going to the combine, evaluating draft prospects.

Why would a head coach without a team go to combines to evaluate players? Coughlin did not want to be at a disadvantage if he was hired again. Not coincidentally, that was where he bumped into the Giants’ general manager, who was astounded by his work ethic and his commitment to process. “You don’t have a team, what are you doing here?” he was asked.

His response: “I will one day, and when I do I want to be ready.”

Not too much later, the Giants hired him, and Coughlin has since become one of the winningest coaches in NFL history. Indeed, the Jaguars’ decision to let him go has been described as one of the 10 worst head coach firings of all time.

According to Coughlin, this was simply the result of dedication to process.

While two-time Super Bowl-winning coaches are process-oriented, Wall Street thrives by appealing to our tendency to be outcome-focused. We rank fund managers, best asset classes, top-performing sectors, highest-returning mutual funds. Note that all of these are ranked not by repeatable process, but by outcome. This is a brilliant bait-and-switch. You don’t know if these outcomes were the result of dumb luck or one-time events or simply a turn of the cycle. The tease is that you, too, can have these fabulous returns if only you invest in these products. Here is the next XYZ, yours for the taking.

If only. A funny thing happens the next year: A whole different set of outcomes “wins.” Different sectors lead, another mutual fund is on top, a new manager is top dog. Last year’s top performers? That was last year! Here are the new winners, ripe for your investment dollars. Wall Street engages in this classic outcome-oriented advertising because it pushes people’s buttons. It sells.

It is not just that “past performance is no guarantee of future results.” But rather, that is an actively misleading goal, the legalese in fine print belied by the headline promise of great riches. I call that “the dangle.” It is the tease that suckers investors in. Any Wall Street advertising that does not go into the boring details of methodology is most likely to be pushing past performance.

Which brings us back to our earlier questions: If you said of your colleague who made all that money, “sounds like he got really lucky,” you are probably on to something. (To the outcome-oriented investor, it may just be sour grapes.) But the process-oriented investor knows that dumb luck is not a repeatable event. It is not anything that can be relied on over time. Indeed, eventually, random outcomes all revert to the mean, meaning that streaks eventually end. Understanding this is a key part of intelligent and rational investing.

Process-oriented investing is a long-term approach to putting capital at risk by owning a broad variety of asset classes, making periodic contributions and regularly rebalancing. You can just hear the marketing guys screaming, “Boring! How can we ever sex up that sort of approach?!”

Focusing on your investment process, and not the outcome, should be your goal. Here is the payoff: Over the long term, a good process delivers highly desirable results, and generates better and more reliable outcomes. There is nothing boring about that.

Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. Twitter: @Ritholtz.

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