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business newsWhat Investors Can Learn From Pilots
The first lesson? Consider that a typical flight starts from the end; a pilot doesn't take off without first considering where she wants to fly.
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Investing, too, is not inherently dangerous; however, it is terribly unforgiving of any carelessness, incapacity or neglect. In flying, the consequences are obvious, dramatic, and easily observable, while in investing, consequences often can't be detected for years and (at least initially) might not seem so obvious. It doesn't make the consequences any less dramatic.
For our purposes, we can learn a lot about becoming better investors by learning from the training and procedures that pilots follow. Consider that a typical flight starts from the end: A pilot doesn't take off without first considering where she wants to fly. That destination can change, based on a number of factors, such as the weather, but the initial goal is to reach a specific destination. An investor, too, should start from the end. Where do you want to go? That goal should probably not be just a specific number, but rather, should include some thinking into a type of lifestyle, work requirements, feelings of security, and transfer of wealth issues.
Once the pilot thinks about her destination, she then fills out a flight plan. Do you have a flight plan for your investments? Is that flight plan about achieving a specific return without considering how you'll achieve those returns or whether those returns are feasible? Does your investment plan take into account your own preferences?
Here's a thought experiment for you, consider two alternatives. In one, you make a set amount each year for 10 years; in the other, you make nothing for nine of those years and then make all of your returns in the last year. After 10 years, both scenarios would yield the same result. Would you realistically be able to stick with a strategy that gives you no return for nine years with the prospect of large returns the final year? Would you be willing to take that chance? What if the scenario changes and the returns in the final year are greater overall, but still only come around once in your investment career? These kinds of questions will impact the type of investments and style of investing that you should pursue. Your flight plan is not only about getting you to your destination, but about identifying markers along the way to check that you are actually moving forward.
Notice that our pilot hasn't flown yet. She has done a lot of the work, and already knows her destination and path, yet hasn't even stepped into her plane. What comes next is crucial: checklists. Pilots, before most other professions, recognized the fallibility of humans. Pilot training depends not on the individual’s ability to memorize, but the individual’s ability to understand processes. Pilots realized that humans have cognitive biases that include confirmation bias, hubris, and cognitive dissonance. The methodology developed for pilots is now used across multiple fields to decrease human error, most notably by doctors who have been shown to dramatically reduce medical errors through the use of checklists. Simple and effective. While the pilot's checklist revolves around checking the physical plane and instrumentation, investors need to have a checklist of accounts, universe of investments, implementation vehicles, and appropriate tracking tools. All of this should happen before any flying.
Planes are fast, but investing is even faster. After takeoff, the pilot is already concerned with the next steps, the next markers, and the requirements coming up. In that light, a pilot's attention is about monitoring the current state, and already anticipating the next stage. The pilot knows that the next stage, the next control communication, the next change in barometer readings, the next ... anything, is coming up quickly. Similarly, investors need to monitor the current state, but already anticipate the next stage. In a passive approach, the investor has determined that he will do nothing. Most people take this approach in their 401K accounts, failing to even reallocate after significant changes to their original allocation by virtue of market moves. This is a shame because even a minimal level of activity around rebalancing can significantly increase long term returns. One level up in activity is a rule-based approach, where investors reallocate based on time (e.g. "I'll reallocate once a year or once a quarter") or some single-factor parameter (e.g. "I'll reallocate when my desired allocation is 10% or more out of balance"). Both of these methodologies will increase an investor's long-term returns without significant effort. At the other extreme is the investor that is actively seeking returns, which can be great or not depending on the process. For the vast majority of investors who aren't spending significant amounts of time on honing their investing skills, the middle road will be the most fruitful long-term method.
Getting back to our pilot and her process, even after she landed, her work is not done. Again, we turn to the checklist, because for the pilot, like an investor, reaching one destination is never the end, so systems and procedures are checked. Lastly, comes a post flight debriefing, where our pilot has to determine what went right and what went wrong. What could improve on the next flight? Investors often get complacent about the debriefing. Great investors don't just come the next day and do the same thing. They determine what went right and wrong with each investment, trade, system, concept, etc.
If you ever met a pilot, you probably know that once someone is a pilot, she is always a pilot. Pilots never stop flying and they never stop seeking out other pilots. For one week a year, the busiest airport in the world is Oshkosh, WI. The little town draws tens of thousands of pilots from around the world who all seek each other out like great migratory herds. Investors are similar. The good ones seek each other out, and look to learn about developments in the field, new technologies, or new nuggets of information they can use. They criticize themselves and try to improve, recognizing their own capacity for errors. They use systems to compensate for their own behavioral biases. They do a lot of work before investing, thinking through the destination, the appropriate path, and the upcoming challenges. Good investors know that investing is not inherently dangerous, but it is terribly unforgiving of negligence, incapacity, or neglect.
Editor's Note: We're pleased to introduce our new columnist, Yaron Sadan of Osher Capital Advisors, LLC (Osher). Yaron also writes and edits The Hard Trade, a financial newsletter focused on risk and asset allocation, behavioral finance, contrarian investing, global macro-economic themes, and geopolitics.
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