The best way to learn from past mistakes – with Joe Wiggins

Financial blogger Joe Wiggins explains how investors can ensure they learn from their mistakes without falling into the behavioural finance trap of succumbing to ‘outcome bias’

25/10/2021

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

Liam Nunn

Liam Nunn

Fund Manager, Equity Value

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Investors, it should go without saying, need to learn from their mistakes – after all, as philosopher George Santayana famously observed: “Those who cannot remember the past are condemned to repeat it.” That said, how can investors ensure they learn from past errors – without then compounding them by focusing more on the outcome of previous events than on how those events played out?

To do so would be to fall victim to ‘outcome bias’, which Joe Wiggins, the author of the excellent Behavioural Investment blog, highlights as one of The five commonest behavioural finance mistakes in the latest episode of The Value Perspective podcast. It is also a subject covered in some detail in a previous episode with US poker player and author Annie Duke though she had her own term for it: ‘resulting’.

“After something happens, everything is binary – you are either right or wrong,” Wiggins begins. “So, rather than people thinking of history as a range of possible paths, it just looks like an arrow and as if everything that happened in the past was destined to be so. After the event, it feels obvious so when we are making judgments about the future, it can feel as if this should be obvious too – either in this or that direction.”

Probability v certainty

Wiggins also suggests there is an issue here that is specific to the world of investment. “Most people in investment are trying to sell something,” he observes. “And generally, to sell something, you need to be confident. If you are talking in probabilities and the next person is talking in certainties, however, then that person is more likely to win the business because you just did not seem that sure of yourself.

“So a range of issues come together to make it actually very rare for people in investment explicitly to express themselves in probabilities. More generally, people are inclined to recoil in horror from the use of probabilities. They tend to think you are being spuriously precise – how can you be ‘57% sure’ of something? – or they think you are just hedging your bets and you do not really have a strong-conviction view.”

For Wiggins, though, thinking probabilistically holds a number of attractions for investors. “For one thing, it immediately highlights uncertainty,” he says. “As soon as you use probability to describe something, you acknowledge the future is inherently uncertain and allows for comparison – comparison through time with a conviction in your view on something, and comparison across different people and what that view might be.

Open to change

“It also just paves the way for allowing you to change your mind. If you frame something as a certainty, it is really difficult to change your mind because you are so committed to that view. But if you say something has a probability of 60%, say, you are admitting it is uncertain and leave yourself open to change your mind. So probabilities absolutely should be used more than they are – but I am not particularly optimistic they will be.”

As to how investors can hope to learn from past mistakes without falling into this trap of focusing on outcomes alone, Wiggins believes the key issue is one of definition. “What constitutes a mistake?” he elaborates. “Like many things in investment, the answer seems easy – surely it is just underperformance – and yet I do not think that really makes sense.

“Let’s say you are a highly skilled investor with, in very simple terms, a 60% ‘hit rate’ – in other words, out of any 100 of your decisions, 40 do not work out or underperform. But do we think those are mistakes? Or are they simply an expected feature of a process? I would argue focusing entirely on those known ‘mistakes’ is the wrong way to go about assessing your process or the quality of a decision.”

Review everything

Instead, says Wiggins, the first thing investors should do is review all of their decisions. “That means the ones that have good outcomes and the ones that have bad outcomes,” he continues. “There will be some great decisions in there that had bad outcomes and vice-versa so you need to try to avoid viewing them through the lens of their outcome alone.

“The key questions you should be asking yourself here are – irrespective of the outcome generated – did we follow the process, did we miss anything and should we adjust the process because of the learnings we have? You should definitely avoid a situation where you make significant changes to a process based on a sample of one – particularly if that negative outcome is in line with what you might typically expect from your strategy.

“The fundamental problem with mistakes is, while people might say a 60% ‘hit rate’ is enough to make someone a great investor, nobody really acts like that when they are observing investors – they act like it has to be 100%. The key for investors, then, is to review all your decisions against your process and, in light of that, assess whether you need to adjust that process because you think it has long-run limitations.”

Author

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

I joined Schroders in 2015 as a member of the Value Investment team and manage the European Value and European Yield funds. Prior to joining Schroders, I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst and hold a Economics degree.

Liam Nunn

Liam Nunn

Fund Manager, Equity Value

I commenced my investment career in 2011 at Schroders as a European equity analyst. I then moved to Merian Global Investors in 2015 to work as an equity analyst & fund manager before returning to Schroders to join the Global Value team in January 2019. I manage Global Income, Global Recovery and Global Sustainable Value.

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