How to Measure Your Success as an Investor
Since I work for CFA Institute, you probably wouldn’t be surprised if I said the best way to measure success is to follow the Global Investment Performance Standards (GIPS). After all, many professionals think GIPS is the global gold standard. Now here’s something that may surprise you: CFA Institute’s standards are a subset of a much better, more comprehensive, way of measuring your success as an investor.
See, in my opinion, the most important skill for investors is understanding information. Or put another way (and more philosophically): To what degree is your mind in accord with reality? If your mind is not in accord with reality, your decisions are based on distorted understanding and distorted information. You may still do well as an investor, but it will be because of luck and coincidence, not skill. Thus, the first job of investors is to understand the world with as little mental and emotional distortion as possible. Harmonize with reality.
I believe definitively that returns are an outcome (i.e., the effect) based on the degree to which you are successful at understanding information (i.e., the cause). In other words, investors almost exclusively assess their skill by analyzing their returns, all the while ignoring the decisions that led to those returns in the first place. Of course, this is not all it takes to be a good investor. But first you must understand information, then, and only then, do you decide what to do with that information.
In the early days of my investment career I was anxious because I needed to know a critical thing: Am I good at this super complex and competitive endeavor, or not? One day I realized in an Aha! moment that the returns of the fund I co-managed did not reflect all of my decisions. Instead, returns reflect only the results of the securities I chose to purchase for the portfolio. Another way to think about it: The portfolio returns directly reflected only a limited number of the affirmative decisions I made, and only indirectly the negating decisions.
What about all of the news I had digested and interpreted to ensure I understood things like GDP, corporate earnings, discounted cash flow analysis, technological trends, demographic shifts, and so forth? What about all of the companies that I had bypassed for purchase because they did not fit my theses, or that did not pass muster after my modeling of their futures? What about all of the management teams I spoke with that failed to assuage my concerns and convince me they deserved my shareholders’ hard-earned capital? What about my failures, near misses, and weighting errors? What about the emotions that distorted my decision-making? And on, and on. As an investor I was making thousands of decisions about my understanding of reality, and the portfolio returns tracked only a super small minority of those decisions. Returns are nice, but they are clearly feedback on only a subset of an investors’ full decision suite.
So I realized that to fulfill my aspirations to be a good investor I needed to record, date, and consistently examine a much higher percentage of my decisions. (Note: I believe it is impossible to record every decision due to the thousands of decisions made daily.) I could then check in occasionally to examine to what degree I was in accord with reality.
Then I had to be unabashed and courageous in examining my failings. Then I had to muster the energy to craft answers to the questions raised by my examinations, then create solutions to those errors, and then I had to muster the courage needed to dare to change.
With all this in mind, I believe the best way to measure your success as an investor is:
- Ask yourself to what degree is your consciousness in accord with reality?
- Gain as much consciousness about your decision-making as is possible (hint: try meditation).
- Record your important decisions in an investors’ journal. This should include the who, what, where, when, why, and how of your investment decisions. Pay particular attention to your emotional state at the time of the decision.
- Review your journal at least quarterly and also whenever a major change in a decision occurs, such as a purchase, sale, or when an investment requires a major decision (e.g., merger or acquisition, CEO change, earnings announcements, etc.).
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
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Jason,
Thank you very much for your thoughts, which resonate with the way I have been thinking about the subject. I have spent a good amount of time trying to narrow down the success in investing to a set of the most important factors and you have touched upon all of these.
I would like to make one important distinction in understanding reality and that is the presence of the element of uncertainty in it. The accurate assessment of reality, which I think of as interplay of the physical processes of different magnitude, indeed plays an important role in determining success in investing. However, the reality that we try to assess as investors isn’t very real as it lies in the future.
In addition to developing a model of the world that closely resembles reality in our minds, a successful investor must also have a good understanding of what that reality would look like in the future. In other words, making decisions based on the accurate assessment of probabilities must also play a role sucessful investing.
Umed
Hello Umed,
Thank you very much for sharing your thoughts and for including the additional views on uncertainty.
With smiles,
Jason
I was hoping you might, in part, measure your success by your ability to influence the direction of the companies you invest in.
Hi James,
Thanks for sharing your thoughts about governance. To my mind, my comments do not preclude good governance. Why can’t those governance decisions be a part of your decision suite?
With smiles,
Jason
I like this statement, because it compels us to ask ourselves what success is? Do we widen or narrow our definition? I guess your answer to that would be based on how you view power. I think it is a good point. Thank you for that expansion.
Hello Akim,
Thank you for sharing your thoughts about success and power. You are welcome for the piece and for the comments above. We are grateful to have you as a reader of The Enterprising Investor.
With smiles,
Jason
There is uncertainty( as an intrinsic element of each phenomena) which is a part of nature, and usually out of control, but understandable. There is another factor which is risk (calculated and under control in your decision making process). I think even emotional moves should be put under risk not uncertainty. These are two different things. It’s doable to minimize risk but not totally get rid of it. There are others events or phenomena based on emotions which affect your rational thinking too, so you see sometimes your rational decisions are made and affected by not necessarily other rational events. In this case you need to be aware and incorporate it into your risk profile. Another thing is to have vision, and see where the trend and future is going,and have a sense of it ( news, politics, etc..). One for reality is to predict the future and as it’s impossible it cannot be necessarily projected in your “right now” moment for decisions.. (talking about uncertainty). We only can prepare ourselves by what to expect for.
Hello Sia,
Thank you for your thoughtful comments. Yes, all of the factors you identify are a part of solving the investment problem. Inescapably: there is no such thing as a future fact. Facts by definition are things that have already occurred. Yet investing is about the future. Investment results unfold in the future. Some people are better at seeing pictures in the mosaic tiles (and at many mental scales) than others. One of the best ways I know how to get better is described in the post above.
It would be interesting to see a record of your investment notes going forward. I am certain that the considerations you describe above would be contained within.
Nice work!
Jason
Sometimes facts are so strong which can be easily seen in future. I agree with mental part and I would say it’s more common sense . Some say intuition. Regarding investment I only would add that my $100k portfolio had a return% of 24 since May 1st. It sounds too good to be true but impossible is not exist in my book! I know my industry and I would add being passionate about industry or areas you are investing goes a long way! It works for me at least. 🙂
Understanding skill versus luck in performance outcomes is critical for long-term investing success. After adjusting for risk and considering costs, most serious studies have concluded fund managers outperform due mainly to luck. See:
Eugene Fama’s and Kenneth French’s 2009 paper, “Luck Versus Skill in the Cross Section of Mutual Fund Returns” which demonstrated that “the high costs of active management show up intact as lower returns to investors.”
Regarding “all of the news [you] had digested and interpreted,” the real understanding is assessing whether any of the news is not already reflected in prices. In highly competitive markets very little news is not already digested. When an investor thinks they have an edge, they should ask whether the institution on the other side of the trade has better information and analysis. My preference is to focus on diversification, taxes and risk premiums while keeping overconfidence, hindsight bias, and other factors in the behavioral finance realm in check.
Hi Paul,
Thank you for your comments and for the link to the paper.
The paper that you highlight and that gained attention via Mauboussin’s book is exactly why I wrote the post. Even more importantly, the reason I developed the technology I discuss above in the post is because as a fund manager I wanted to absolutely have a way of ensuring that I could develop skill so that I would be able to separate skill from luck. If I record the reasons for my choices ex ante and then reality unfolds how I described it then I can be pretty sure that the performance I am logging is not due to luck. The study you quote above extracts its information from returns data, not from choice data. The distinction as I highlighted in my post is that only a very small subset of your choices are reflected in a portfolio.
Cheers!
Jason
Jason — No doubt there is a lot to be learned from logging the rationale motivating a trade and reviewing it later. If you will indulge me, I am suspicious of choice data. It would seem your description of the choice would have to include “GDP, corporate earnings, discounted cash flow analysis, technological trends, demographic shifts, …” relative to what is in the market already. If you expect earnings to be up in a quarter, buy and then discover everyone else had the same expectation such that the stock declines, is that due to skill or luck? The decline may be totally unrelated to earnings and instead an effective tax rate change, R&D miss, market share decline. My point is there are a ton of variables that affect price and, it would seem, ample room to attribute performance to the wrong reason.
Hi Paul,
No doubt there are many variables that affect any movement of anything in the universe; I would agree with you. I would like to point out that you have narrowed your feedback mechanisms enormously by insisting on price movements as the only source of information about the state of the world.
What if you write in your diary: “Had interview with CEO of XYZ company and he assured me that they would not invest more capital in Brazil; but I think he is lying to me. I would expect them to have to sink more capital into Brazil to shore up their operations there within the next six months”? And then, lo and behold, the company invests more capital in Brazil in a years time despite the absolutist statement that they would not do such a thing. Whether there is a price movement or not, this is feedback on your ability to understand information.
Your comments are insisting on a success measurement that I am writing about as incomplete: returns. So at the outset we have a disagreement in denominator. Yes, returns are important as an outcome of choice, and hence a source of information; but certainly no the only source of information. That’s all I am saying.
Wouldn’t you like to be evaluating all of your choices, not just those that are captured by returns? I think the primary job of an investor is to understand information. Only if you are doing that well can you then be wise, intelligent, and decisive in your decision making: to buy, or not to buy. So my preferred source of evaluation is: To what degree is your consciousness in accord with reality?
Hope that helps to clarify my point of view.
With smiles,
Jason
Hi Jason,
I did not mean to suggest that success was only about returns (but it does seem that in the competitive world of mutual funds, returns are the only factor that counts). Rather, success in advising individuals and families on how to reach their financial goals encompasses not only after-tax returns but a discussion of risks and the consequences of being wrong.
Your point that the primary job of an investor is to understand information is spot-on. Important in that understanding is knowledge of financial history.
My personal understanding is that markets are practically efficient (few can produce long-term alpha after including costs and identifying those superior managers in advance is quite difficult). Instead pursuing alpha through tools and tactics discussed in my blog post (linked to my name above) is more rewarding than security selection and market timing. This understanding is my conscious reality.
Best regards
Paul
What is reality ? is this found in outside world or our desires and inclination for occurrence of an event.
What is the role of intuition in investment
I experienced several times that inner desire resulted in desired outcome.
Its not rocket science. Look at the most successful investors in the world, no one is expert of such scientific research. They simply applied common sense , shows patience for occurrence of favourable event with optimism and they are successful.
Hello Muhammad,
Thank you very much for your comments!
With smiles,
Jason
Thank you sir,
I understand your reply “with smiles” .
I did not mean that simplistic approach overrule all the analysis and advanced studies but to indicate another dimension and personal experience of mine.
Thank you very much
Seasons Greetings Jason!
Your comments are perceptive and enlightening, truly there are many psychological constructs like self fulfilling prophesy that come into our decisions in daily life. That said in order to avoid information overload, one does require a set of criteria to decide. My favorite decision rule is to identify the critical success factor (for that endeavor) and work on that. I am 🙂 to note that meditation is now in the tool kit of the investor!
Have a gr8 day!
Hello Charu,
Yes, seasons greetings to you as well. I really like what you have added to the discussion here. I agree that decision rules are an important part of attaining discernment. By the way, you might also like my post where I evaluate some of the more common mental models. Perhaps you have already seen it? https://blogs.cfainstitute.org/investor/2014/10/07/skills-that-separate-you-as-an-investment-manager-discernment/
Last, thank you for taking the time to share your wisdom!
Jason