Streetwise for Sunday, August 7, 2021

Investing is a one to three-year undertaking and the reason is simple; it can take time for the performance of a company’s shares to reflect a company’s financial performance.

Yes, the uncertainty and volatility of the financial markets can be unnerving. And yes, it is natural to lose faith when the day’s trading activity shows a sharp decline among the major equity indexes, such as we seen over the past several months.

However, remember that market direction in the short-term is both uncertain and unpredictable. However, a company's prior accomplishments are ascertainable with a degree certainty, thereby enabling a determination future performance with a reasonable degree of probability.

Speaking of probability, readers may recall that in the past I have discussed Annie Duke and her book “Thinking in Bets.” (A book I still highly recommend.)

Duke points out that most decisions we make are under uncertainty. They are heavily influenced by luck, or by hidden information. We fool ourselves into thinking otherwise.

Maria Konnikova, whom I have also discussed in the past, has directed a degree of effort to better discern the line between skill and luck. More specifically about what an individual can control and what they can not. And like Duke, she also became a champion poker player.

Armed with a doctorate in psychology, Konnikova's book, "The Biggest Bluff," is ostensibly about the interplay between luck and skill.

Like Duke, Konnikova delved into the "Theory of Games and Economic Behavior," by John von Neumann and Oskar Morgenstern.

Von Newmann’s book essentially created what we refer to today as modern game theory. (I highly recommend the book to those with a quantitative bent.)

Von Newmann’s seminal about strategy was largely inspired by poker. A brilliant mathematician and strategist, Von Neumann wrote that poker represented, in Konnikova's words, "that ineffable balance between skill and chance that governs life."

Von Neumann believed if he could figure out how to disentangle chance from skill and thereby maximize the role of skill, while minimizing the malice of chance, he would arrive at the solution to some of life's greatest decision challenges.

In discussing stock selection, Konnikova also references Nobel laureate Daniel Kahneman, who believes that the selection of stocks by mutual fund managers has a greater attribution to rolling dice than playing poker.

According to Kahneman, the successful fund managers in any given year are largely lucky; meaning they have a good roll of the dice. Meanwhile, there is general agreement among researchers that nearly all stock pickers are participating in a game of chance."

Thinking like a poker player could well be an important way to minimize the element of chance in investing and heighten the element of skill. Every investor feels invincible when the chips are falling their way. Suddenly, their superb investment acumen has gained them entry into the winning circle of investors.

However, it is not about your reaction to winning, but your reaction to losing. As pointed out by Dan Harrington, a respected author of books on poker strategy everyone plays well when they are winning. The key is to implement self-control when losing.

The crucial element according to Konnikova and many on the Street is learning how to take emotion out of decision-making. As an analogy, consider the experiment done by Walter Mischel.

A psychologist, Mischel conducted the famous marshmallow test, or delayed gratification test. One version had children in a room with a treat, often a marshmallow, which they could either eat right away or hold off, knowing their reward for doing would be a second marshmallow.

The marshmallow tests were conducted in the 1960s. Mischel then followed his subjects for decades afterward. He found that those who were able to hold off eating the first marshmallow fared better in life than those who lacked that self-control.

You might want to think about that the next time you find yourself carried away by the ebullience or negativity of Wall Street.

Lauren Rudd is a Managing Director with Raymond James & Associates, Inc., member NYSE/SIPC. Contact him at 941-706-3449 or Lauren.Rudd@RaymondJames.com. All opinions are solely those of the author. This material is provided for informational purposes only, is not a recommendation and should not be relied on for investment decisions. Investing involves risk and you may incur a loss regardless of strategy selected. Past performance is no guarantee of future results.