The Problem With Great Expectations

“There is hardly any activity, any enterprise, which is started
out with such tremendous hopes and expectations, and
yet which fails so regularly, as love.”
– Erich Fromm

I once pitched a real estate deal to a small group of affluent investors. I was (very loosely) projecting annual profits in the 25 to 35 percent range. That’s a healthy return, but not unusual for limited partnership real estate deals where investors can lose all of (but not more than) their original investment.

After I finished explaining the deal, a man in the back of the room raised his hand. I acknowledged him. “I wouldn’t think of investing in a deal like that,” he told me.

“Okay,” I said, and looked around the room for other questions.

“Don’t you want to know why?” he asked me, visibly upset at my nonchalance.

“Not really,” I said. “I’m sure you have good reasons.”

“But I want to tell you,” he said.

“Okay,” I said. “Tell us.”

“I have high standards,” he said smugly. “I never invest in anything that won’t at least double my income on an annual basis.”

“Aha,” I said. And then I took some other questions.

Whether we do it consciously or not, we all set expectations for every event we take part in, every task we undergo, and every challenge we accept. Some success experts tell us that it is better to set our expectations high, because we can achieve more that way. “Shoot for the stars,” they say.

The idea that you’ll get more if you have higher expectations has a certain logic to it. We have all had the experience of succeeding at something we thought we would fail at. “Holy cow! I won that Scrabble game. I guess I’m a better player than I thought.” And how many times have we seen our favorite team overcome a stronger opponent and achieve victory?

These experiences teach us that (a) it is possible to underestimate what you can do, and (b) you never know how well you will perform in a challenging situation until you try.

We don’t want to lose for lack of trying, so the intelligent coach will do everything he can to put the expectation of success in the mind of his athlete. Visualization – the technique by which the competitor imagines vivid details of the competition and sees himself merge victorious – is an important and useful method for overcoming doubt and building confidence.

But even in sports, setting high standards and achieving them are two different things.

Marcus, my martial arts instructor, is a professional fighter. Before each contest, he convinces himself that he will emerge victorious. He visualizes his fight, sees his hands raised afterward, and talks about the match as if his victory were a foregone conclusion. This positive mental attitude was a factor, no doubt, in his beating the world champion in his weight division two months ago. But it didn’t help him last week when he lost to another top-10 ranked fighter.

When I begin a new business, I set expectations. Not just one – a group of them. These expectations take form in profit-and-loss projections over, usually, one-to-five year spans. At the one end is the “What will it look like if nothing works well?” scenario. (That’s usually a very miserable picture.) On the other end is the “What will it look like if everything goes perfectly?” scenario. (And that looks great.) Then we have two or three projections in between.

By putting all the possible projections in front of you, you can begin to think about how to handle certain contingencies if they occur. By having detailed scenarios to look at, you can prepare yourself for just about anything.

This process, as you can see, is not about setting high expectations. It is about researching possible outcomes and then thinking about how they can be achieved and/or dealt with.

Do I never set high expectations in business?

Well, I must admit that, in starting a new business, there is almost always a time when my partners and I sit around the table (usually with drinks in hand) and imagine how great things will turn out if the business goes as well as it possibly could. If that is setting high expectations, I’m guilty. But that’s the extent of it. I don’t wake up every morning and tell myself, “Ten million by 2007 or die!”

Setting high expectations can be effective in sports performance and other areas of personal achievement, but it is not a good idea – in my view – when you’re investing in liquid markets like stocks, commodities, precious metals, and real estate. As an investor, it is wise to have expectations that are only slightly higher than realistic.

Setting high expectations only to fail to meet them time and time again is a recipe for unhappiness. And when it comes to your passive investments, that’s what’s likely to happen. Because the typical investor has neither much definitive knowledge about these investment vehicles nor much (if any) control over the outcomes.

I wonder how all my investment-recommending colleagues (and investment-buying readers) are feeling these past few weeks when just about everything out there is getting clobbered. I suspect those who set high standards are feeling pretty bad, whereas those who set more realistic goals may be feeling better.

Setting high ROI goals is bad for two reasons: (1) you are much more likely to be disappointed, and (2) you are much more likely to make bad decisions.

Assuming you are mentally tough enough to deal with disappointment, you still shouldn’t set your investment goals too high. If you do, you will pass up good investments because the yield they promise will be below your threshold. (Like that man did who didn’t want to hear about my real estate opportunity – which turned out to be something like a 1,000% hit over four years.) And you will buy into investments that turn out to be well-hyped crap. (That same man invested in a competing real estate project that is about to declare bankruptcy.)

So what should you do?

I can’t say exactly. Everyone’s situation is different, but my personal goal in passive investing is to achieve current market rates. That’s why I’m happy to invest the majority of my portfolio in index funds, municipal bonds, and cash equivalents. Although I do believe it’s possible to beat market averages by consistently following the advice of someone with a very good, long-term track record, I don’t always have the discipline to do that. So it works for me to expect the average.

Bill Bonner, writing in the Daily Reckoning recently, explained why his expectations for his investments are even lower than mine:

“While we are on the subject of our own investing, we would like to confess that we do not even try to make a profit from our investing. We only try to preserve our capital. Why? Because we have been very lucky in business … lucky in love … lucky in family … lucky in so many ways. Expecting to be lucky in our investments would seem like ingratitude on our part.”

As I said, whenever we invest our time or money in anything, we set expectations. What we don’t want to do is shoot too high when investing in things about which we have little knowledge and over which we have scant control.

So why do some people – like that man in the back of the room – consistently expect what only a fool would expect?

There can be only two answers: greed or desperation.

Don’t be greedy. Don’t be desperate. Invest wisely. Don’t worry. Be happy.

[Ed. Note: Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Palm Beach Letter. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.]