Between Scylla and Charybdis
Vol #45 - July 2nd, 2021
(Programming Note: The Till will be off next week, returning July 16th. Happy Fourth of July!)
Sometimes you're left between a rock and a hard place, other times it’s between the devil and the deep blue sea. Choices have never been easy.
Homer personified this damned if you do, damned if you don’t dichotomy as the mythical characters of Scylla and Charybdis, haunting ancient sailors.
The dual scourges of Mediterranean navigation sat at the southern tip of Italy between Sicily and the mainland. Scylla was the six headed monster representing the rock shoals off the Calabrian coast, and Charybdis was the swirling eddy on the Sicilian side.
Navigating these dual hazards was critical for easy access between the Eastern and Western parts of the ancient world. When navigators met this strait, they were forced to thread the needle between two equally dreadful outcomes. Or even worse, as Erasmus warned - “having escaped Charybdis I fell into Scylla.”
Not only must we choose between the lesser of two evils, but be careful not to jump out of the frying pan and into the fire. The popularity and variety of phrases describing this scenario indicates the frequency with which we still find ourselves in this type of situation.
As investors every decision we make feels fraught with potential “what ifs”. When I’m selling stock, that means someone is buying. If you generally believe in the efficient market hypothesis- that all securities currently trade at roughly the fair market value of future returns - any trade you make can feel like a treacherous decision.
Investing is a game of forecasting. In its simplest form it’s about selecting the securities that will deliver the greatest absolute returns and profit maximization. (Anyone who tells you that’s a “simple” process is probably selling you a subscription service.)
What makes personal wealth management even more difficult is that it’s about forecasting the size and shape of your own needs - something that may be even more fickle than market microstructure. How can we predict not only where the market will go, but when and how much money I’ll need or want?
A useful framework for thinking about this type of problem is to identify the difference between type I and type II errors. Type I errors convict an innocent person, and type II errors let a guilty person go free.
Extreme policies eliminate one risk while guaranteeing another. Owning only US treasuries insures your savings will be intact, but poses significant risks to purchasing power.
When navigating between two extremes, what error are you most likely to commit? Which would be worse? If you’re more comfortable with the delicate navigation required near the shoals, it would be reasonable to bias your course towards the mainland.
Regret minimization is another useful framework here. It sounds like a gruesome schoolyard scenario - but would you rather crash into the rocks or drown in a whirlpool? We not only have to play into what we’re good at, but do what feels good - or at least doesn’t feel bad. The answer is rarely the same for different people.
Some traders prefer to be long, others prefer to be short. It’s nothing more than style - money can be made both ways. Would you rather sweat at night over the fact that nothing is happening (long) or over the fact that something could (short)?
It’s important to note that choices are rarely as static as the allegories suggest. Door #1 and Door #2 are neither packaged neatly, nor represent permanent decisions. A choice is a singular event, but investing is much more like the active process of navigation.
In the book “Superforecasting” Philip Tetlock and Dan Gardner talk about how constant updating is important for making good predictions. As new information comes to light, it’s only reasonable to update a forecast.
The best forecasters are willing and able to synthesize new details without the dogmatism of any viewpoint. Conservatives may only look at a social policy through a framework of costs and morals, while liberals might do the same about military spending. Superforecasters only see facts and probabilities.
Once again, investors are met with a multi-headed hydra of mandates. Not only do we have to navigate between the straits, but we’re saddled with the meta cognitive burden of how frequently to update our course.
Updating too frequently risks mistaking the noise for the signal. For investment horizons longer than a few years, daily updates are rarely significant, and means your portfolio will get chopped up by fees and head fakes.
Every journey is different, and investors must ultimately choose a course they are comfortable with. Best practices, unbiased advice, and transparent facts help make these decisions easier, but decision making is a process, not an event.
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