One of the books that has captured my attention during these past days is "Good to Great: Why Some Companies Make The Leap And Others Don't" by Jim Collins.
The book is enjoyable and well-written but most importantly has several ideas that have made me re-think certain concepts. While I certainly recommend the entire book, one of the most relevant concepts that I have encountered is what the author calls the Stockdale Paradox. This concept applies not only to companies but also to us as individual investors looking to improve our performances.
The Stockdale Paradox got its name from Admiral Jim Stockdale, who was the highest-ranking U.S. military officer in the "Hanoi Hilton" war camp in the Vietnam war. He was in prison from 1965 to 1973 and was tortured over 20 times during his imprisonment. He lived out the war with no prisoner's rights, no set release date and no certainty of seeing his family again. He went on to become the first three-star officer in the history of the Navy to wear both aviator wings and the Congressional Medal of Honor.
When Collins interviewed Stockdale, he was intrigued by how was he able to manage such pain over the years.
"I never lost faith in the end of the story. I never doubted not only that I would get out but also that I would prevail in the end and turn the experience into the defining event of my life, which, in retrospect, I would not trade."
Collins remained silent, and after a long pause, he carried on: "Who didn't make it out?" Stockdale provided an answer that left me thinking for a long time.
"The optimists. Oh, they were the ones who said, 'We're going to be out by Christmas.' And Christmas would come, and Christmas would go. Then, they'd say, 'We're going to be out by Easter.' And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart."
Then, Collins mentions, Stockdale provided a very important lesson.
"You must never confuse faith that you will prevail in the end – which you can never afford to lose – with the discipline to confront the most brutal facts of your current reality, whatever they might be."
So as investors, how many times have we taken the role of the optimists? How many times have we set high expectations on an investment, only to be disappointed as time progressed? The key lesson to take from this is that we should be flexible and willing to adapt our ideas to new information. As humans, one of the psychological biases that we suffer from is consistency bias, which makes us feel the need to avoid sharp contrasts with our previous beliefs and/or opinions. However, in a fast-changing world like ours, it is naïve to think that our view shouldn't change hand in hand with the relevant facts.
Facing the brutal facts will not only make us less prone to error but also provide a good understanding of the relevant risks that could affect our capital. The Stockdale paradox is not about abandoning the ultimate belief that we will prevail, but it is combining that optimism with a willingness to face the facts that could provide early warnings to us. As investors, it is critical not only to be proud of our capabilities but also to be sure of our processes, and facing the brutal facts could be of great help in avoiding confirmation bias and creating a better investment process.
This connects directly with what Keynes once mentioned: "When the facts change, I change my mind."
What do you think?
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