A Model for Better Decisions

Thomas Hobbes described life as “solitary, poor, nasty, brutish, and short,” but in the spirit of a long holiday weekend I will try to keep today’s newsletter upbeat, light, and short. But Hobbes, like myself, was a bit of a curmudgeon, which is probably why I immediately attached myself to his words when I first encountered them in a university philosophy course. I tend to be pessimistic, assuming the worst from people and from events. Naturally, I used to view the optimists around me as naïve and ill-informed. Gradually, I awoke to the realization that neither optimists nor pessimists are right 100% of the time and that optimism and pessimism are merely adjustable perspectives or filters to decipher information. While an optimistic outlook is useful for tackling big projects and starting new ventures, a pessimistic outlook is useful in keeping us safe from swindlers, schemers, and tiger attacks. One trait is an attacking force the other is a defensive force. While each has upsides, both are prone to potentially major negative consequences.

Take the optimistic entrepreneur, doubtless a positive outlook is crucial in launching each venture. We marvel at the spirit and success of an Elon Musk or Bill Gates, but their success came at the expense of thousands who failed. The world is made by these people, but it took the trial and error of many failures to achieve each successful outcome. If instead of looking at the individual success story we viewed innovation as one large organism we see that the output isn’t just a Tesla automobile or an iPhone, but the inventor themself, they are the ultimate output.  They rose because others failed. We are inspired to be optimistic because of those success stories, but we rarely see the stories of those who failed before them. Optimism creates both marvelous innovation and bankruptcy at the same time.

On the flip side, the pessimist focuses intently on the potential for failure. The pessimist takes profit where the optimist rides the winner. The pessimist assumes behind every corner lurks disaster waiting to destroy him. In a world run by pessimists it is likely we’d still be debating the efficacy of the invention of the wheel. “Sure it’s good for getting around and transporting things, but just last week it ran over my toe. Next thing you know it’ll kill my dog,” the pessimist would mutter aloud. It’s likely, the extreme pessimist would never go bankrupt, but he’d also never cross the road.

It would be nice to become a perfect blend of optimist and pessimist. The problem is that while we can make strides to become less pessimistic or more cautious, whichever the case may be, it’s unlikely that we can ever fundamentally change our personality. The situation can seem futile, but all is not lost. This is where model building can come to the rescue. Some models are quantitative, algorithmically based computer programs, while others are just a simple checklist to run over before making decisions. Whatever the case may be, models are extremely useful in protecting us from ourselves.

When it comes to investing, models protect us from many poor behavioral decision making flaws. Model-based investing prevents us from being controlled by our fear (pessimism) and our greed (optimism). Models can help us cut losers (pessimism) and stay with winners (optimism). Models can help us remove the filter with which we decipher information to view data more agnostically and not selectively seek out certain information which simply confirms our pre-existing tendency to be overly optimistic or pessimistic.

Fear and greed are the two emotions that get investors in trouble. While it is often said that successful investors are the ones who are fearful when others are greedy and greedy when others are fearful, but it is hard to know if your timing is right, and uncertainty creates indecision. A model helps erode some of that indecision. No model is infallible, but each well-constructed model can be a steppingstone on the path to better decision making.    

Happy Memorial Day out there,

Zach and Dave   

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