Investing is about being mostly right

As a professional money manager, I regularly faced difficult decisions when selecting stocks. Often, the stocks I considered were cheap due to bad news. The problem then, as now, was to determine if a particular stock's price had declined due to serious missteps — the classic value trap.

Our obvious goal was to avoid those and to find cheap stocks whose problems management could solve to restore robust earnings growth. As we struggled to select these stocks, my former colleague inevitably quipped, "Well, it's either the warning bell or the dinner bell." And there, of course, is the rub.

When faced with complex decisions, investors might keep in mind the words of former Secretary of Defense Donald Rumsfeld, who said, "There are known unknowns ... things that we know we don't know. But there are also unknown unknowns ... things we don't know we don't know."

What to do about the things we don't know we don't know? Or more simply, how do we determine if the warning bell or the dinner bell is about to sound?

Investors must remember that unlike the absolute precision of a mathematical equation, investing is about being mostly right. I have yet to meet an investment manager whose portfolio is populated entirely with winners. Though we strive to do thorough research, generating strong returns is actually about getting more decisions right than wrong. The unknown unknowns keep us from batting 1.000, but, in fact, we don't need to. Investing is not like building a bridge or a plane, where a modest miscalculation can potentially cost lives. Rather, investors should be satisfied with being mostly right most of the time.

In April 2003, I gave an interview to the Wall Street Transcript discussing my top five stock picks. Ten years (almost to the day) later I, quite by accident, rediscovered the article. I was curious how those stocks had performed over that fairly tumultuous 10-year period. Each company was an industry leader that had become attractive to my value-oriented stock selection discipline. There were knowns and unknowns to be sure; still, despite three of the stocks underperforming the market over the 10-year period from April 11, 2003 (when I gave the interview) through April 12, 2013 (when I rediscovered it), the entire portfolio returned more than double the S&P 500.

My five stock picks were up 249.7 percent; the market, 109.4 percent. Genentech (purchased by Roche Holdings in 2009) and Disney dramatically outperformed, while the other three stocks-— Cisco, Citigroup and General Electric — underperformed, with Citigroup actually generating a negative return. Still, my portfolio did just fine.

Walt Bettinger, CEO of Charles Schwab, said, "Being in the market is more important than when you are in the market."

I've made that point before — add it to your list of knowns as you make stock-selection decisions that by their nature include unknown unknowns.

Coming up, a four-part series on retirement planning. Send in your questions. Nancy Tengler spent two decades as a professional investor. She is an author, financial-news commentator and university professor. Her book, "The Women's Guide to Successful Investing," is out now. Reach her at nancy.tengler@cox.net.