7 Traits for Investing Greatness:
#6 Probability vs. Possibility
#7 Discipline

Categories Author: Jim O'Shaughnessy, Investing

As I cautioned earlier (see Parts 1, 2, and 3), it’s harder than you’d think to stick with an Active approach to investing. Traits #6 and #7 (of 7 total) outline two more ways for Active investors to achieve greatness over the long term:

#6 — Probably, or Possibly?

Successful Active Investors Think in Terms of Probabilities.

“You don’t want to believe in luck, you want to believe in odds.”

— Charlie Munger

We are deterministic thinkers living in a probabilistic world. We crave certainty about how things will unfold, which is precisely why we fall for predictions and forecasts. Yet, even in the most prosaic of circumstances, nothing in the stock market — or in life — is 100% certain. But many people confuse possibility with probability and the two are almost exact opposites. Think of Jim Carrey’s Dumb and Dumber character Lloyd Christmas. When reacting to the out-of-his-league Mary Swanson rejected his romantic advances, she told him his odds were “… more like one out of a million.” His response, after a long pause to calculate: “So you’re telling me there’s a chance. Yeah!” Poor Lloyd mistook possibility with probability, having failed to understand that the probability of ending up together with Mary was virtually zero.

If we focus on “possibilities” rather than “probabilities,” we become lost. Almost anything is possible, even when highly improbable. If we think only of possibilities, it would be hard getting out of bed in the morning. It’s possible that you will get hit by a bus, get accosted by a stranger, get killed by a crashing plane or, more brightly, win the lottery, despite the very low probability of any of these events occurring. Focusing on possibilities can lead us to a state of constant fear — thus our craving for orderly, known, and “certain” information and actions.

Life doesn’t work that way. According to Richard Peterson’s Inside the Investor’s Brain (see our Blog’s Feb-2017 review of his book), “When an outcome is possible but not probable, people tend to overestimate its chances of occurring. This is called the possibility effect … Emotions in uncertain or risky situations are more sensitive to the possibility rather than the probability of strong consequences, contributing to the overweighting of very small probabilities.”

A great real-world example of people thinking in terms of possibilities rather than probabilities was during the financial crisis — people actually sold out of all their long-term investments, and I know of at least two investors who put large sums of cash into their safety deposit boxes. They were most certainly thinking of possibilities rather than probabilities.

A study we conducted in 20091 looked at the 50 lowest 10-year returns for the US market since 1871 and found that the 10-years ending Feb-2009 are the second lowest in more than 100 years. Importantly, we looked at what happened after those horrible periods, and found that the 50 returns over the next 3 to 10 years were all positive. This led us to conclude that the probabilities were quite high for the market to do well in the 10-years after Feb-2009.

To succeed, investors need to determine the probabilities of a certain outcome, and then act accordingly. Knowing the probabilities gives you a strong edge over people who don’t know them or choose to ignore them. If you, like legendary card player and investor Ed Thorp,2 can count cards in blackjack so that you know the probabilities of what the next card is likely to be, you have an enormous edge. The same holds true for any number of professions: life insurance companies use actuarial tables to predict the probability of someone dying; casinos use probabilities that allow the house to always win in the end and colleges and universities rely on educational tests to determine who gets a spot at their institution.

In the stock market, I believe the surest way forward is to look at the long-term results for an investment strategy and how often — and by what magnitude — it beat its underlying benchmark. For example, this table3 illustrates the results of simply buying the 10% of large stocks with the highest Shareholder Yield (dividend yield plus net buybacks) over an 80-year sample:

Base Rates vs. All Large Stocks (1927–2009)
Highest-Yielding Decile of Shareholder Yield in Large Stocks
table

Over all 961 rolling 3-year periods, you can see that the top Shareholder Yield group beats other large stocks 81% of the time by an average 3.24% per year. When you extend it to all 877 rolling 10-year periods, the base rate jumps to 97%. Now, look at this through the lens of Dumb and Dumber’s Lloyd Christmas: there’s a 4-in-5 chance of winning over any given 3-year period. On the flipside, however, it also informs us that we have a 1-in-5 chance of losing to the benchmark!

Few investors pay much attention to base rates, and study after study has shown that when you introduce any information in addition to the base rate, people usually ignore the base rate in favor of the often-useless anecdotal information. Even though the rational thing to do is bet with the “base rates” and accept that we will not always be right, we are forever rejecting the long-term evidence in favor of the short-term hunch, even though our probability of being correct plummets.

We also ignore probabilities when we enthusiastically buy a story stock that is incredibly expensive — the 3-year Base Rates for buying stocks with the highest P/E ratios is just 20%, losing 8 of 10 rolling 3-year periods.

What’s the bottom line? Knowing the past odds of how often and by what magnitude a strategy either outperforms or underperforms its benchmark gives you an incredible edge that many people ignore. Successful Active investors know this and pay close attention to this information, thereby putting the probabilities on their side.

#7 — Discipline

Successful Active Investors are Highly Disciplined.

“Discipline is the bridge between goals and accomplishment.”

— Jim Rohn4

It is easy to say is that you are an unemotional, disciplined investor — right up until when the market goes against you and you throw in the towel. Here’s a short quiz, to help gauge the likelihood of your actualization:

Did you …

  • sell most of your equity holdings during the financial crisis?
  • enthusiastically buy tech stocks in 1999?
  • ever let a prediction or a forecast influence your dealings in the market?
  • blame events or other people for what happened with your investments?
  • ever ignore all the evidence and probabilities and decide to just “take a flyer” on a stock or a fund?
  • ever invest in something because the majority of other investors were also doing so?
  • ever abandon a well-tested and well-thought-out investment strategy because it had recently been doing poorly?

The upside: If you answered “yes” to several of these questions, congratulations! You are a normal human being. The downside: Chances are, you may lack the discipline required to succeed as an Active investor.

Being highly disciplined is extremely difficult. It goes against almost every impulse we have baked into our genes. Sure, it’s easy to be disciplined when things are going your way; when you are significantly outperforming your benchmark. However, real discipline is what kicks in when things are going against you, sometimes significantly. When every week seems like a month, when you are filled with self-doubt and constantly questioning every single part of your investment process, when others express skepticism about your core beliefs, and even friends and colleagues begin to doubt you and your process — that’s when discipline is required.

And, boy, does your mantra change. You know then what it’s like to feel horrible about yourself and your ideas, and all of a sudden you really understand the opening of Shakespeare’s 29th sonnet:

“When, in disgrace with fortune and men’s eyes, I all alone beweep my outcast state, and trouble deaf heaven with my bootless cries, and look upon myself and curse my fate…”

That’s when you need discipline, if you are to succeed.

And, like most things in life, that’s precisely the moment when you want to shout: Stop! Every event and news item you see is the opposite of what you believe, and your emotions and intellect implore you to “Stop!” And every single thing you read or hear people say just reminds you that you are wrong, that you must abandon your silly persistence and allow this pain to stop. Just let it stop. The emotional pain is so overwhelming that it feels like slow torture, day in and day out, and all you need do to make the pain go away is to abandon your silly process and allow yourself to breathe.

If you continue to stick with it, even when every single thing conspires to dissuade you from consistently applying your investment ideas and principles, you’ll also know that you may be wrong for a lot longer than you think you can endure. What’s worse, you won’t have to just put up with your own fear, doubts, and pain. Instead, you’ll often be derided, mocked, and ridiculed by many other people who’ll simply think of you as a fool. All the recent weight of the evidence will be on their side. Not only that, but experience teaches that these detractors don’t come alone, they come in crowds. The criticism can be deafening, snide, and cruel, which can devastate your psyche. According to a March 22, 2012 article in Psychology Today magazine, “The (Only) 5 Fears we all Share” are:5

  1. Extinction
  2. Mutilation
  3. Loss of Autonomy6
  4. Separation7
  5. Ego-death8

Each of these also plays a part in feeding your self-doubt and the desire to abandon your discipline, but the last 3 Fears (#3–5) are the cruelest in this instance because they feed into everything you are feeling at the time of greatest risk.

The only thing you can do is hang on to the idea that “this too, shall pass.” Not much of a lifeline, is it? I go on at length about this because I have been there — more times than I care to remember. Indeed, absent discipline, all 6 of the other emotional and psychological traits (barriers to successful Active investing) are worthless. And the question you must answer honestly is: “In the throes of underperformance or rocky market conditions, do I really have the discipline to remain unemotional and stick to my plan?”

According to a recent post by Ben Carlson discussing Charlie Munger’s ability to withstand drawdowns, he wrote: “Many people simply weren’t born with the correct wiring to be so unemotional…The ability and willingness to take risk are not always equal for most investors. Charlie Munger is a [unicorn]. It’s good for investors to remind themselves of this when trying to emulate him. Very few can.”9


I believe that you can do significantly better than indexing your portfolio passively, IF you possess the 7 traits laid out in this article and you can enforce them with a disciplined commitment over time. But, as Mr. Carlson points out, very few of us can.

If you are one of the few, I think our current environment and the rush of investors into Passive products will only increase your chance of doing much better than an index — but you must employ these 3 simple tips:

  1. Be brutally honest with yourself.
  2. Keep a detailed journal of all your investments and note when you succeed and when you fail.
  3. Work on your weak points until they are eliminated.

If you can manage all this, you’ll become a member of a shrinking, and yet potentially lucrative, club. As you’d expect, club membership is limited to long-term, Active investors.


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  1. Bookmark: osam.com/10YR-Real-Average-Annual_1871-present.pdf
  2. See Ed Thorp’s acclaimed A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market (Random House, January 24, 2017)
  3. From the 4th Edition of What Works on Wall Street
  4. For more Rohn-isms, go to jimrohn.com
  5. See psychologytoday.com/blog/brainsnacks/201203/the-only-5-fears-we-all-share
  6. Loss of Autonomy: The feeling of “being controlled by circumstances beyond our control.”
  7. Separation: The feeling of “rejection, (and) not (being) respected or valued by anyone else.”
  8. Ego-death: “Fear of humiliation, shame…or the shattering…of one’s constructed sense…of capability and worthiness.”
  9. See entire post here: AWealthofCommonSense.com/2017/02/where-I-disagree-with-charlie-munger