Decision Making: Process vs. Outcome

The Safe and Cheap blog was meant not only to be an exercise in Value Investing, but also, and importantly, a journey towards better Decision Making. Although I've often found that the worlds of value investing and good decision making are intertwined, I reckon a separate post on the importance of 'process' is warranted.

The essence of this post is this - Bad process will inevitably produce bad long term outcomes, they might however, produce good short time outcomes. On the other hand a good process, if efficiently executed, will naturally, over time, lead to good long term outcomes. I would like to emphasize long term here as even a good process will unavoidably lead to bouts of bad short term outcomes. It is important to note that, bad short-term outcomes do not necessarily imply a bad process, but the importance of luck in success.

Consider the game of golf (which I love, no..hate, nah..love), which highlights the importance of process than no other. In order to execute a good shot, it is important that you, (a) have a decent swing (backswing, downswing and follow through), (b) a proper grip, (c) a good stance, (d) focus, and importantly, (e) keep your eyes on the ball. Having said that, there might be times when you don't do any of these and hit a good shot, but make no mistake, you will not be able to hit anything close to a 72 when you play a round. This is because over time, this bad process will catch up to you and produce a bad overall, long term (over 18 holes) outcome. A good process however, might lead to a bad shot or two; (1) perhaps because you took your eyes off the ball - a mistake in execution, and/or (2) because wind suddenly starts blowing and herals your ball to a tree (I am sure golf enthusiasts will understand) - the cause usually is a known unknown or an unknown unknown. But overall, you have the chance of hitting a good long term score. The same analysis can be applied to most sports. In professional sports , skill is also a big factor, which essentially comes from the perfection of a process. Likewise, if you regularly drive fast - well you get the point.

But we ain't in the discussing academics business, we in the allocating capital (and making money) business. Retail investors often focus on the historical performance of a mutual fund. A fund with good historical performance numbers usually attracts more capital, while a fund with bad short term performance usually faces withdrawals. Is this warranted? Sometimes it is, and sometimes it's not! We have to analyse the process each manager is following, and then reasonably determine, (a) if the process makes sense, (b) if it will make money, and importantly, (c) what is the downside (and if I am comfortable with that downside). A good manager with a good process may produce bad short results, but over time, the performance of the fund ought to reflect the superior course of action. In keeping with the disclosures, I have never been able to nail down George Soros process of making money (well not fully), and he produced good results and did it over a long period of time (If I was an academic, maybe I'd talk in sigmas). Likewise, in stock selection, it is important to focus on the process, and importantly, the downside risks, than worry about the outcomes. This process, coupled with heaps of discipline, over time, will inevitably lead to good long term results. It is also noteworthy that the inputs to the process are of prime importance. Bad inputs, coupled with a good process, will lead to a bad outcome - Garbage In Garbage Out (GIGO) principle.

In conclusion, all other things being equal, generally:
1) Bad Process, Bad Outcome - Inevitable in the Long Term
2) Bad Process, Good Outcome - Luck (outcomes from known unknowns and unknown unknowns are favorable) - a Short term phenomenon
3) Good Process, Bad Outcome - Luck (outcomes from known unknowns and unknown unknowns are unfavorable) - a Short term phenomenon
4) Good Process, Good Outcome - Inevitable in the Long term