Investing Like John Wooden

These days it is more or less common knowledge that our brains are not evolved for investment success. In fact, our brains are evolved to keep us from investment success. I don’t have anything profound to say on the science behind this. If you are interested in the science, I would recommend reading Thinking, Fast and Slow, by Daniel Kahneman.

Rather, I want to focus on how we can deal with our evolutionary disadvantages.

There is much investing literature insisting the solution to our cognitive and emotional biases is simply to think as dispassionately and analytically as possible. That sounds nice on paper. However, I don’t think it is realistic. I don’t believe it is possible to completely cut emotion out of the investment process. I would argue that if you think you have successfully removed emotion from your investment process what you have really succeeded in doing is deceiving yourself.

It is both healthier and more productive to openly acknowledge that investing is a difficult, emotional process. Better to channel your emotions toward productive ends than waste time and energy denying they exist.

For me, this means measuring success by the quality of your investment process and the consistency of its implementation–not the daily, weekly, monthly or even annual tape print. If you have a quality process and implement it consistently, and you strive for continuous improvement, you will do okay in the long run.

Think of this as the John Wooden approach to investing:

When Wooden arrived at UCLA for the 1948–1949 season, he inherited a little-known program that played in a cramped gym. He left it as a national powerhouse with 10 national championships—one of the most (if not the most) successful rebuilding projects in college basketball history. John Wooden ended his UCLA coaching career with a 620–147 overall record and a winning percentage of .808. These figures do not include his two-year record at Indiana State prior to taking over the duties at UCLA.

What’s more, Wooden openly shared his secret sauce:

John_Wooden_Success_Pyramid

Here are a couple of the ways I strive to channel emotion into process and not into a self-defeating obsession with outcomes:

  • I keep an investing journal where I document research, investment theses, thesis breaks, trades and post-mortems of exited investments. I will also write own my feelings and views of difficult situations or frustrating outcomes.
  • My emphasis is always on following my process. Making money on random gambles or “lottery ticket” type investments doesn’t count as success. My process does not revolve around “making money.” The goal of my process is to validate or disprove investment theses.
  • Thus, selling out of a bad investment is not failure. Exiting bad investments quickly allows me to redeploy that capital into better quality investments. Some of the worst investing mistakes (think Valeant) have been made by people being unwilling to admit they are wrong.

For a process-oriented investor, much of what passes for “investing” seems silly–like poker players on a tilt or dogs chasing cars.

Making Mistakes

Investing is a humbling activity. Mistakes are inevitable. Every Warren Buffett has his Dexter Shoe Company. On top of that, there is the old saying that the market can stay irrational longer than you can remain solvent. It is often difficult (many would argue it is impossible) to distinguish between results generated through skill versus luck.

Because of this it is absolutely essential to focus on process versus outcomes. There are times you will make “mistakes” because of bad luck, despite a solid process. Other times mistakes will result from process gaps or failures. In this way you can distinguish versus “good mistakes” and “bad mistakes.” 

Good mistakes happen when you identify the correct investment thesis and you do the analysis but the investment position does not “work” (maybe because of timing). An example of this is the legion of short sellers who had The Big Short trade on in housing and mortgage bonds but ran out of time before the payoff, either because their investors ran out of patience or due to other portfolio issues.

Bad mistakes result from analytical blind spots or insufficient higher order thinking. Bad mistakes are things you should be getting right more often than not. If you dip-buy a bunch of oil companies following an oil price crash, for example, and you are not hedged to the commodity, and oil prices collapse further, and you lose even more money, then that is a bad mistake. You have fallen into a classical value trap.

The very worst mistakes are unforced errors stemming from laziness and/or hubris. Bill Ackman’s Valeant investment was the absolute worst kind of bad mistake. Not only did Ackman get Valeant spectacularly wrong, but he repeatedly deferred to Valeant management and rejected evidence contrary to his investment thesis. The result was a $4bn loss to his investors

Extrapolating beyond investing, this becomes a pretty robust framework for thinking about daily life.

Bad shit happens in life. A lot of the worst of it is completely out of our control. However, there are plenty of things you can control on a daily basis. The most foundational of these is awareness of your thought patterns and behavior.

A surprising number of people do not choose to live a particular way so much as default to the behaviors that come most naturally to them. To these individuals, every misfortune is bad luck or the cosmos conspiring against them. I guarantee you have met someone who fits this profile. You are likely related to at least one of these people: someone who is perpetually ill, or short on cash, or falling victim to some “random” calamity, pinballing from one misfortune to the next.

If your process for daily living involves no conscious effort at maintaining your health, mental acuity and financial stability, you will always be vulnerable to the random shocks the cosmos throws at you. These shocks are also more likely to have a catastrophic impact.

Process, process, process! Mistakes are inevitable. What is not a foregone conclusion is what, if anything, you will learn from them.