LeBron will probably stay with the Heat; how I came to that conclusion can apply to portfolio management.
In all likelihood the best player in the NBA isn’t leaving
the Heat. As someone who likes the Cavs,
I am a tad bummed; however, the Cavs and Heat should both be very entertaining.
On the surface this has little to do with your portfolio,
but let’s use this as an example:
- What I did in the above picture is list reasons why he would stay on the Heat and why he would leave.
- Everything in the above picture I deem as signals, items that indicate the direction of the ultimate outcome.
- Items above the red are why I think he stays, and below why he might leave (though those are more mixed).
- Anything else I hear about LeBron I deem as noise, distortions that cause a loss of focus on what is the likely outcome. For example: his kids are enrolled at school ABC, his wife wants to move back to Akron, he wants to play with Carmelo, etc.
- Thus, given the signals as I read them the evidence is overwhelming he stays.
In short, I ignore the noise and read the signals to
formulate that thesis. But in practice it
isn’t that simple: maybe some of the noise were actually a signals OR vice
versa OR one of the mixed signals comes to fruition OR I missed something
entirely OR maybe I am looking for confirmation bias. Despite the sound process in theory, it
certainly isn’t infallible given the highly subjective nature.
When it comes to portfolio management, I apply the same
decision making process – look for signals (e.g. + likelihood of solid economic
growth, + loose Fed, - uncertainty of QE unwind, +/- above average valuation)
and ignore the noise (e.g. whatever is going on in Ukraine, endless Fed
comments) to formulate a thesis (e.g. the background for stocks should be
positive though with some headwinds).
Much like my LeBron thesis, the above can ultimately prove
to be untrue as my assessment of the signals is subjective. However, unlike like the LeBron thesis there
are more objective signals from the market I can incorporate into portfolio
management in the event my thesis fails.
It’s these objective signals that help hedge against the “OR” mistakes
listed above, a luxury that wasn’t available when I formulated my assessment on
LeBron.
So while in portfolio management it’s imperative to ignore
noise and pay great attention to signals when going through the process, it’s
equally imperative to have measures in place to guard against making the wrong
decision. The latter may not help
figuring out where LeBron will land, but it could help minimize your drawdowns
when the market corrects.
Please see the
important disclosures that apply to this commentary HERE.
