The Odds of Success & Failure
When I share sometimes that the lack of success doesn’t imply failure, and the lack of failure doesn’t imply success, my audiences seem baffled. First of all, what is a success, and what is a failure? For the purpose of this essay, let’s call success the achievement of a chosen goal. Failure would be then reaching the least desirable outcome. They are not opposites or two sides of the same coin. They are two destinations in different directions. On our journey towards the desirable outcome, we may fall and get uncomfortably close to the undesirable one. It’s helpful to see success and failure this way, making life and investment decisions. Let’s see how and why.
I like exaggerating ideas, taking them to their logical limits to make a point, and showing something interesting. In the case of money, wealth, and riches, let’s say that becoming the richest person in the world is our ultimate measure of success. At the same time, becoming completely broke, homeless, and living on the street as a failure.
I remember the last evening before my flight to New York City to start my internship. This opportunity later turned into a full-time position and led to a career path I’m still happily on. It’s amusing how our memory selects one moment over the others. A New York movie was on TV that night. I had already been there and knew it quite well. To my family, it was still an undiscovered corner of the world. The movie was a story of two homeless men played by Danny Glover and Matt Dillon. They kept trying to “make it” and break away from life on the street, yet failed each time.
I enjoyed the movie; it was New York, after all. My family grew even more worried about my decision. They told me I really have to take care of myself there. I did. The image of ending up homeless on the streets of New York became a symbol of failure in my mind. I remember walking past homeless people in many cities around the globe, and I still carry spare change for anyone in need.
At the other end of the spectrum, to exaggerate here a bit, one can picture becoming Warren Buffett as the ultimate success. He might still be living in the same house he bought over half a century ago, but I think he is quite comfortable financially and has no money worries.
In investing, one could define success as keeping and growing a nest egg, a fortune, to a level when work becomes optional. On the other hand, ending up with empty pockets and not even any spare change for coffee at the other end.
Why contemplate this frame of thinking? The simple truth is that each reward comes with risks. I notice how often investment discussions focus on the upside. This stock can go up 20% or double, or be 10x an investment. Some investors hope to find that one stock that will make them rich, while other investors daydream about compounding their wealth at 15%-25%-35% a year for decades and becoming the next Buffett scale successes. It’s all about the rewards.
What about the risk? What about failure? And here, I don’t mean getting richer slower than your neighbors. That’s not risk, that might be a source of frustration, but it’s really meaningless to anyone looking at investing as a way to keep and grow wealth over the long run. Losing money, a permanent loss of capital, that’s a risk. The ultimate failure in investing is losing a big portion of one’s wealth. It’s a very personal decision what ‘big’ means in this context. If one loses half, it will take doubling of what’s left to recover. A 90% loss would require 10x on the remaining capital. If an investment has a minimal chance of recovery, it’s a total loss, not a paper loss anymore. It’s almost impossible to recover.
As much as easy winnings can convince some investors of their genius and invincibility, losses have an impact on the investor psyche, too. The bigger the losses, the bigger the upside is needed to potentially recover. As you might have guessed, that upside comes with ever bigger potential risks. It’s no surprise how this can lead to a quick downward spiral, just like a gambler doubling the stakes with every loss.
There are many stories of hugely successful people that made a fortune so big that one couldn’t imagine ever spending or wasting it away, yet they did — from the Vanderbilts to Great Depression era speculator Jesse Livermore to a much more recent billionaire investor Bill Hwang who managed to part with $20 billion in 2 days.
The legendary investor Charles D. Ellis said: “Large losses are forever – in investing, in teenage driving, and in fidelity. If you avoid large losses with a strong defense, the winnings will have every opportunity to take care of themselves. And large losses are almost always caused by trying to get too much by taking too much risk.”
We always start with the downside, and to keep it simple, we have a no zero policy. We choose not to invest in any stock that we can imagine going to zero. There will be ups and downs and volatility on the way, and not all investments will perform as expected, but zero is not an option.
Warren Buffett repeatedly reminds us that Rule #1 of investing is not to lose money. We also agree with Ellis that the upside will take of itself. We are in no rush. Slow and steady wins the race.
Our mantra of keeping and growing wealth without the risk of losing it all encompasses both our definition of success and failure. We make an educated assumption about the odds of both. We believe that being aware of the two destinations at all times can hugely improve the quality of the investment process.
Years later, living in Manhattan, I ran into Danny Glover, the actor from the movie I watched that memorable evening before my flight to New York. We passed each other a few blocks away from my home. I smiled. That encounter brought back some memories.
As much as we all want the upside, it’s good to be reminded of how much we wouldn’t like the ultimate downside. There is a happy middle; we just need to keep finding it with every life and investment decision. Even if we don’t end up as rich as Buffett, we’ll be just fine, as long as we don’t allow the other extreme to enter the realm of possibility.
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