In the first post of this three-part series, I offered the observation that many of the principles involved in successful money management are also those that are successful in life. The first principle was the value of cash in our portfolios--and unstructured time in our lives--to best position us for the pursuit of unexpected opportunities. In this post, we'll look at the value of taking a process orientation to success, rather than one that focuses strictly on outcomes.
Process Versus Outcome In Money Management
It is understandable that traders and investors tend to set goals in terms of return on their capital. After all, that is why they're putting their money to work! Interestingly, however, the outcome focus ends up placing a magnifying glass on short-term returns, leading to fight-or-flight emotional responses, biases in decision making, and a failure to trade one's plans after having planned the trades. In part, this is because we respond differently to losses than gains and are more likely to sell winning trades and hold onto losers--the well-known disposition effect.
There is a more subtle problem with setting outcome goals for trading and investment: it tends to frame wins as successes and losses and failures. Over any near-term horizon, market outcomes are sufficiently random that even a skilled investor can experience drawdowns and runs of losing trades as well as winning ones. If the winning periods are taken as evidence of hot hands and losing periods as evidence of slumps, traders will be most likely to ramp up their risk-taking when they are overconfident and shun opportunity due to underconfidence.
Consider the investor who is profitable half of the weeks during a year, with the average size of gains during winning weeks significantly exceeding the average size of losses during losing weeks. With a 50% weekly hit rate, that investor has about a six percent chance of encountering a run of four consecutive losing weeks. That makes month-long "slumps" inevitable for someone trading throughout the year. If our investor frames goals in terms of monthly outcomes, "failures" become inevitable. This becomes particularly problematic when, losing money day after day, week after week, investors stray from past patterns of success and begin tinkering with sounds methods in hopes of avoiding losses.
It is equally problematic should our investor become supremely confident after a random run of four winning weeks and begin betting ideas much harder. The focus on recent returns easily leads to a distorted perception of risk/reward and outsized drawdowns once winning trades lead to huge bets.
The emotional ups and downs of tethering self-perception to the gyrations of markets, as well as the biases that result, are the reason that successful money managers learn to frame goals in terms of processes rather than outcomes. Over time, successful investors develop processes for researching opportunities, translating those opportunities into positions, and managing those positions within a broader portfolio. Goals are framed in terms of adherence to best practices, much in the manner of Gawande's checklists. Any trade can win or lose, given the vagaries of news flows and world events at any particular time; the process-oriented trader is concerned with placing the right trades for the right reasons, not with making money at any particular juncture.
A good example of the process mindset is the baseball batter who focuses on taking good swings with proper form and reading pitchers well--not on whether they will get on base at any particular at-bat. Similarly, a physician follows evidence-based protocols in conducting a surgery, recognizing that outcomes will be best if proper processes are followed. When best practices become the barometer of successful practice, the investor is most likely to make reasoned, planned, and sound decisions. Recognizing that it's possible to trade badly (in the process sense) and make money just as it's possible to trade well and lose money helps money managers divorce their self-esteem from their daily fluctuations of profits and losses.
Becoming Process Oriented In Our Self-Management
In an excellent post, James Clear makes the case for forgetting about goal setting altogether and instead focusing on what he calls systems. He cites several examples of a system focus, including the coach who gauges success by the quality of daily practice, rather than the attainment of a championship, and the entrepreneur who emphasizes daily activities of sales and marketing rather than the size of the business being built.
Goals, Clear points out, can decrease our happiness by turning desired outcomes into burdensome expectations. Instead of gauging success by the number of pounds lost, a dieter is more likely to find success in a daily regimen of healthy eating and exercise that become enjoyable routines. With consistency and a sound process, positive outcomes naturally follow.
Barry Ritholtz offers an excellent example of the psychological benefits of a process orientation. When New York Giants coach Tom Coughlin was fired by his previous team, he still went to the NFL Scouting Combine and scoured for talent as if he were still a head coach. When asked what he was doing at the Combine, Coughlin responded that he would have a team someday and wanted to be ready when that time came.
Had Coughlin focused solely on outcome, he might have been depressed by his firing. Instead, grounded in process, he remained opportunity-focused.
In a recent post, I expanded on the topic of gratitude and the mindset that everything in life offers us either blessings or lessons. Positive psychology research from Robert Emmons points to a wealth of emotional and health benefits to gratitude. Such gratitude is possible once we adopt a process mindset that pounces on setbacks as lessons. When we can learn from what we do well and also learn from what goes poorly, we always come away with something that moves us forward.
In life as in money management, doing the right things yields superior outcomes. Pressuring ourselves for outcomes helps us do wrong things. A championship season is the result of many successful practices and games. A successful investment career is the result of days, weeks, and years of sound research and thoughtful risk management. A lasting, loving marriage results from many individual acts of caring, sharing, and mutual sensitivity.
Imagine organizing your life around the five PERMA elements associated with optimal psychological functioning: Positive emotional experience; Engagement and absorption in life activities; fulfilling Relationships; a sense of Meaning and purpose; and valued Accomplishments. Each day's entries in the planner would include activities that embrace those elements; each day's tasks would be consciously undertaken in the spirit of increasing PERMA. That is a process orientation to life: one in which positive psychology brings favorable life outcomes.
