The Importance of an Investment Process


Let me set the scene.

Last Sunday morning I was driving on the Kiama bends on the south coast of NSW, Australia. In my rear vision mirror, I happened to notice a car cornering substantially faster than any other car. It was approaching my car very quickly.

Somewhat expecting the driver to do something silly, I proceeded to watch the car swerve up the inside of two cars driving in the right-hand lane. Now driving right behind me, the driver used the slight gap between the back of my car in the left lane and the gap in front of the car in the right lane to squeeze in and take off down the road.

I then watched this p-plater overtake a car on double lines in the distance before going out of view.

While I find witnessing these people on the roads very concerning, implicit in this decision making and behaviour can be an important lesson for investors.
Over our lifetime, we invariably make millions of decisions. Some will be good and some will be bad. However, as humans, we have a tendency to focus on the outcome of a decision in accessing how good we are rather than the process.

The young P plate driver most likely achieved his objective that day (i.e. arrived at his destination in the shortest possible time) so will have no reason to critique his method of getting there. Though, how much of this positive outcome was attributed to randomness (luck) and how much was due to his process?

If most of his outcome was attributed to luck (as I would suggest it was) then the law of large numbers will most likely one day catch up to him and he will eventually have an accident. The situation is no different to investing. Bad processes can produce good outcomes for a period of time but eventually, bad processes (or worse – no process at all!) are typically exposed for what they really are. Luck eventually runs out and the GFC is a perfect example of this when many people lost over 50 to 60% of their portfolio.

I can’t recall where I came across the below table years ago but I made a point of saving it because it aligned so heavily with AFF’s views on the importance of having an investment process.

I suspect that as humans we tend to focus more on the outcome of a decision as it is much easier to observe than the intricacies of the process leading to it. Regardless of the reasons why we do this, using signals that were caused by randomness (luck) to assess how safe or strong our portfolios are is a sure recipe for an eventual disaster.

As investors we have little control over the movement of markets. What we have at our disposal in our endeavour to achieve good outcomes is complete control over our process. Focus on that and the results will show. How fast are you driving now?