A trip to Lake Wobegone

Lake WobegoneThis trip is for the stock traders among you.

What kind of annual return are you aiming for?

30% or 20% or 10%? What’s your number?

Humans, and especially those of the male persuasion, have a bias called The Lake Wobegone Effect.  They have the tendency to overestimate one’s own abilities resulting in unrealistic expectations.  It is named after the fictional town created by Garrison Keillor, where “all the women are strong, all the men are good looking, and all the children are above average.”

That combination of overconfidence and misplaced expectations are a killer in the markets.

Consequently, the decision process that men use to assign capital to a trading account tends to be colored by the unexamined assumption that the trader will be successful and that warnings about risk of loss do not really apply to him.

Unfortunately, this sets up the naïve trader for a fall, because without mentally preparing for losses and ‘assuming’ them in advance, one will be shocked by the experience of one’s first serious drawdown (a larger decline of your portfolio).

This shock will be amplified many times over if the capital used for the trading account was actually savings, not risk capital.  There’s a difference; a huge difference, but some people will overlook it.

THINK like a successful trader

If you live or die on the outcome of every trade, stop it.   Start thinking like a successful trader: Each trade is only one of many trades I will make and added together, they will reveal both my edge and my trading performance.

And now for the investors among you who have read so far and said to themselves “Lucky me, I am not a trader, so this does not apply to me”:  Whether you’re willing to admit it or not, one of the reasons that you often underperform simple portfolios is because you are far too impatient and undisciplined (this fact might apply to the author too, but I am consciously aware of it and actively working against it).

You are constantly chasing past performance by dumping underperforming funds/ETFs/equities and investing in those funds/ETFs/equities that have recently done well.  It’s a recipe for disaster because you’re always one step behind in both directions as any sort of alpha that does remain in the markets is always going to be cyclical.

Add all of this up — unrealistic expectations, a poor appraisal of past performance and a ridiculously short-term mindset — and you have exactly the wrong way to invest.

The most important part of any investing strategy is your ability to stick with it.  A subpar investing strategy that you can stick with and apply consistently will nearly always outperform a brilliant strategy you give up on.

Your final investing results probably won’t be determined by whether you currently use a strategy that historically delivers an extra 50 basis points of return.  What will matter is whether you had the disposition to stick with investing, however you chose to do it, through thick and thin.

Because you can only lie to yourself for so long before reality sets in and the markets don’t cooperate.

After some bigger market moves in the US-market over night I usually cannot wait to get to my computer in the morning and proceed to do absolutely nothing.

Companies earn profits, and over a long period of time those profits accrue to shareholders.  If I leave it at that – and I really should – investing is such a basic game that doesn’t require much action after you are invested.  I will never be able to run a marathon in an hour.  No use trying it.  Choose to prosper slowly.

All I have to do is keep my head on straight and not screw it up.  That’s the only skill investing requires these days.

So what this trip to Lake Wobegone should remind us of is that not everyone can be smarter than the collective intelligence of millions of other investors.  Some, however, are a little more patient and less emotional.  That’s where the potential for “your edge” is found.

What's your edge?

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