Have A Margin of Certainty
“If you are a smart and experienced investor you know there is always a ‘but’ somewhere.”
– Joachim Klement, CFA
“You need to have a margin of certainty and also understand your odds of being wrong.”
– Preston McSwain
The comments above were part of an exchange the two of us had on a recent call. That candid conversation about our shared investing experiences from different parts of the world sparked this joint post.
If you are a smart and experienced investor, you know that no matter what you do, there is always a “but” somewhere. Every time an investor buys a stock, publicly or privately, somebody else must sell it. When you buy, you’ve just paid more for that stock than someone else thought it was worth. That’s the “but”.
Knowledge has never been fixed. But we now live in a world where the speed with which information is shared has grown exponentially.
In the investment world, the speed of knowledge transfer makes markets more competitive than ever. Information moves freely and globally – often in microseconds. To have an edge, you need a healthy margin of certainty that you have better information than hundreds of thousands of extremely well-educated and well-resourced investment professionals from around the globe.
A level of uncertainty will always exist and analysis paralysis is a problem. Decisions need to be made. The trick is not to be overconfident.
Human nature being what it is, we tend to become more certain of decisions once we have made them. This cognitive effect can put a person in a corner when investing – so confident of a choice that changing course is inconceivable for far too long.
History is filled with examples of investors getting trapped in corners. As an example, earlier this year, many realized that COVID’s impact on global markets would be seismic. Some took action to sell stocks to avoid what they thought would be a long-lasting bear market. The problem was that the length of the bear market, which was already well developed by the time many sold, was not knowable.
Without fully understanding all the issues surrounding COVID, all areas of the economy that would be impacted by it, and how various segments of the market would trade and for how long, did many sell too much in an effort to avoid “certain” losses?
Have many investors who sold in the spring gotten trapped in a corner, never getting back into the market and thereby missing out on one of the largest positive runs in market history?
When it comes to investing, being overconfident and reaching for a big upside win or downside protection save can be costly.
Investing involves risk and we aren’t suggesting that you don’t keep your eyes open for rewarding opportunities.
Just don’t be too certain you are right. Understand your margin of certainty.
Ask yourself what can happen if you are wrong.
Don’t put yourself into a corner that you cannot get out of.
Joachim Klement, CFA
A special thank you to our guest author, Joachim Klement. Joachim, is a trustee of the CFA Institute Research Foundation and offers regular commentary at Klement on Investing. In addition, he is a regular contributor to the CFA’s Enterprising Investor forum.
Klement is the past CIO at Wellershoff & Partners, an independent consulting company for family offices and institutional investors. Previously, Joachim was the Head of the UBS Wealth Management Strategic Research team and Head of Equity Strategy for UBS Wealth Management.
Klement studied mathematics and physics at the Swiss Federal Institute of Technology (ETH), Zurich, Switzerland, and Madrid, Spain, and graduated with a master’s degree in mathematics. In addition, he holds a master’s degree in economics and finance.
More from Joachim can be found on his website and blog at the following: