Outcome Bias and Investing

Outcome Bias and Investing

How to Choose your Results When Investing



How would you like to choose your results when investing?

As it turns out, we all do! It is a common bias called the outcome bias.

Also known as “resulting,” the outcome bias is common (and deadly) to investors.

You choose your results when you don’t realize the role luck plays in your life. Should you choose good luck or bad luck?

Let’s look at a common way investors blow themselves up—outcome bias and investing.


What is the Outcome Bias?

Outcome bias is judging a decision by its eventual outcome rather than on the quality of the decision. It can result in further bad decisions, especially if you feel lucky!

After all, success is largely due to luck.

So, if you picked an individual stock that did well or timed the market successfully, it was just luck! Just because you had a good outcome doesn’t mean you made a good decision!

If you don’t understand that, you are apt to keep playing the lottery—which is how the average person invests—and you will keep getting lottery-like results.

There is no luck in investing.

You cannot time the market, and no one knows the future. If you think you made a good decision, it is just luck! You cannot pick stocks or beat the index. No one can.


What is Resulting?

You might think you did. That, my friend, is resulting. Resulting makes stock pickers rich by convincing others that their luck is skill.

Resulting is the idea that you made the right decision if you got the right outcome. Or conversely, if you got a bad outcome, you must have made a bad decision.

So when resulting, 1) it is outcome bias if you made the decisions and 2) hindsight bias if you wish you made the decision.

Hindsight bias is the tendency  to see the result as inevitable after an outcome is known. “I knew this would happen, or I should have seen it coming.”

If you made a good or bad decision, the best thing to do is acknowledge that you were lucky.

Just have the right strategy.



How To Be Lucky When Investing

So, how can you be lucky when investing?

(T)here are only three kinds of market forecasters. Those who don’t know, those who don’t know they don’t know, and those who know they don’t know but get paid a lot of money to pretend they do. ~Larry Swedroe


If you want to be lucky when investing, don’t conflate strategy with outcome.

It is ok to be wrong about the known unknowns as long as your strategy is sound and considers both success and failure in advance.

In poker, just because you lost a hand doesn’t mean you played your cards wrong. Sometimes luck—just the deck’s draw—makes or breaks your hand.

That’s just like investing!

As long as your strategy is sound, the outcome and results will be exactly what you want. Because how could it be any other way?


How to Choose your Results When Investing


No one can predict the future. As I quip in my bit on chaos theory and investing, economics is the study of what we get wrong specifically, and macroeconomics is what we get wrong in general.

You can choose the results you get when you invest because you have to do it when the time is right. You have to pick a strategy and thus pick your luck.


You reach a crossroads at specific points in your investing career and must decide.

I like to make as few decisions as possible, so when young,  I like broadly diversified, low-cost ETFs. You buy them when you have money and sell them when you need cash. Easy. No thinking is required, and I know exactly what result I will get. I’ll get whatever luck brings. Perfect.

Next, another crossroads is the decision to de-risk your portfolio and take some chips off the table.

You understand that you want the last doubling of your portfolio, but you don’t want to get thrown out at home plate.

By the last doubling—think about this: if you get 7.2% returns every year, you double your money over a decade (the rule of 72).

So over four decades, 500k grows to 1M, 2M, and then 4M.

If you don’t get that last doubling, you have 2M for retirement instead of 4M. Those last ten years, well, it is important to stay invested!

But on the other hand, due to the fallacy of time diversification, the risk of owning equities increases over time. The next market crash is always more likely tomorrow than today, so you don’t want your 4M to get cut in half right before you reach home plate, either!

At some point, regardless of the results, you must pick a strategy. And chances are you will be wrong but might still have a good result. That is when you don’t conflate strategy and outcome.


When Your Strategy is Always Wrong!

As no one can predict the future, no one can pick the assets that will perform the best in any cycle. Luck will cause a few to believe they can, but time will soon disabuse them of any such notion.

Focus on the quality of your decision, knowing that you had to decide, and let the results fall where they may.

If you made the right decision at the time with the information in hand, and managed upside and downside risks, then the results almost don’t even matter. You could not have done better.

You did the best you could with what you knew at the time. If you had known better, you would have done better.

Outcome Bias leads to poor investing hygiene as you assume facts not in evidence.

Planning for a known unknown future involves making the best decision you can at the time and not resulting as the future becomes the present.

Remember, stock market investing often depends on what you don’t do!

Don’t sell low. Don’t rebalance at the worst time. Remember: just stand there and do nothing.

Just standing there doing nothing is the right move most of the time.

And the irony: the smarter you are, the harder this is to do.


Smart People are More Prone to Resulting

As with overconfidence bias, intelligent people are more likely to resort to resulting.

This is because we tend to reject input contradictory to our beliefs, and smart people have well-thought-out belief processes. Or at least we tell ourselves we do!

Also, remember the bias where we take credit for good outcomes and blame exigencies or others for bad outcomes? This self-serving bias often is a primary root of resulting.

So, smart people wind up resulting. And what is interesting, even if you know you are smart and thus more prone to overconfidence and resulting, it doesn’t help you result less! You cannot out-think resulting!

Like an optical illusion: knowing it is so doesn’t make it go away!

Outcome Bias and Investing


Look above. Even though you know all the lines are the same length, you will never actually see them as the same length.  You cannot out-think an optical illusion!

Just like with optical illusions, knowing about resulting doesn’t make it go away.


Summary—How to Choose your Results When Investing

Be clear on this fact: you will often be wrong when investing. So just assume you will be wrong.

By being wrong, you can let go of future predictions and market timing. Instead, you know your outcome because luck determines what you get.

There is no crystal ball. Know that you are the greatest enemy to your wealth!

Don’t fall prey to the human tendency to think that you recognize patterns and can make the right moves; the best thing to do is usually nothing.

We all are resulters.

To lessen the effects of resulting: Make things as simple as possible—but not simpler than that—and then wait.

The best investing is simple: save some money, continuously invest rationally, and then wait 20 years.

Don’t beat yourself up for making the right decision with the information you had at the time, even if it doesn’t turn out optimally.

Instead, set up your strategy such that you are ok with any result. That is a result you can live with.


Things turn out best for the people who make the best of the way things turn out. ~John Wooden

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