Page 137 - Morgan Housel - The Psychology of Money_ Timeless Lessons on Wealth, Greed, and Happiness-Harriman House Limited (2020)

Two things cause us to avoid room for error. One is the idea that somebody
must know what the future holds, driven by the uncomfortable feeling that
COBACOBA
comes from admitting the opposite. The second is that you’re therefore

doing yourself harm by not taking actions that fully exploit an accurate
view of that future coming true.

But room for error is underappreciated and misunderstood. It’s often viewed
as a conservative hedge, used by those who don’t want to take much risk or
aren’t confident in their views. But when used appropriately, it’s quite the
opposite.

Room for error lets you endure a range of potential outcomes, and
endurance lets you stick around long enough to let the odds of benefiting
from a low-probability outcome fall in your favor. The biggest gains occur

infrequently, either because they don’t happen often or because they take
time to compound. So the person with enough room for error in part of their
strategy (cash) to let them endure hardship in another (stocks) has an edge
over the person who gets wiped out, game over, insert more tokens, when
they’re wrong.

Bill Gates understood this well. When Microsoft was a young company, he

said he “came up with this incredibly conservative approach that I wanted
to have enough money in the bank to pay a year’s worth of payroll even if
we didn’t get any payments coming in.” Warren Buffett expressed a similar
idea when he told Berkshire Hathaway shareholders in 2008: “I have
pledged—to you, the rating agencies and myself—to always run Berkshire
with more than ample cash ... When forced to choose, I will not trade even a

night’s sleep for the chance of extra profits.”⁴⁴

There are a few specific places for investors to think about room for error.

One is volatility. Can you survive your assets declining by 30%? On a
spreadsheet, maybe yes—in terms of actually paying your bills and staying

cash-flow positive. But what about mentally? It is easy to underestimate
what a 30% decline does to your psyche. Your confidence may become shot
at the very moment opportunity is at its highest. You—or your spouse—
may decide it’s time for a new plan, or new career. I know several investors