Show Notes
The Probabilistic Decision Protocol (PDP) is a simple four-question filter for doing that. It is not designed to make you more active. It is designed to keep you from being casually wrong.
Here are the four questions.
- Why do you expect positive returns?
- Does it meaningfully improve your portfolio?
- Does it introduce unnecessary complexity?
- Are you ignoring base rates or extrapolating recent success?
Question One: Where Should the Return Come From?
Start with the return because it sounds obvious, which is exactly why people skip it. You should be able to explain, in one or two sentences, where the return is supposed to come from.
The strongest answers tie back to productivity: profits, dividends, interest, rent, or a well-established risk premium. Those are the fundamental building blocks of long-term wealth creation.
Assets that do not produce cash flows can still rise substantially in price. They may even serve a separate purpose, such as insurance or a store of value. But their returns depend more heavily on future demand and what the next buyer is willing to pay. You should be honest that the case is more speculative.
Now think about the AI fund from the beginning of the episode. The companies inside it are real, productive businesses. So the idea does not automatically fail Question One. But that does not mean the fund belongs in your portfolio. Passing one question is not the same as passing the protocol.
Question Two: What Does It Actually Add?
Begin by taking the return you think you are buying and subtracting the drag that comes with owning it: fund expenses, trading costs, turnover, and taxes. Those frictions compound against you year after year.
If the idea still looks attractive after costs, ask whether it improves the overall portfolio. It needs to do at least one of two things: increase expected returns enough to matter, or meaningfully improve diversification.
But owning more stuff is not the same as being more diversified. Once you already own a broad portfolio, another holding only helps if it gives you genuinely different exposure.
Ten funds that all own the same U.S. mega-cap technology companies are not ten diversifiers. They are one trade split into ten line items. That is why many thematic funds do not change the portfolio the way investors imagine. They often repackage what you already own, charge more for it, and leave the portfolio even more dependent on the same companies.
If you call something a diversifier, you should be able to explain what it diversifies against and when you expect it to help.
Question Three: Is the Added Complexity Worth It?
Complexity often looks like sophistication. Most of the time, it creates more ways to make a mistake.
Every new investment creates another position to monitor, another thing to rebalance, another tax decision, and another headline that can pull at your attention. In calm markets, that may feel manageable.
In rough markets, those extra decisions are often what drive bad behavior.
Complexity is not automatically bad. Sometimes it earns its place by solving a real problem. But the expected benefit should be large enough to justify the extra cost, oversight, and temptation to tinker.
My test is simple: can you explain the investment’s role and risks in plain language in less than 90 seconds? If you cannot explain how it works and how it can fail, you are trusting a black box.
A simpler approach may not feel as sophisticated, but it is usually easier to understand, easier to maintain, and easier to stick with when sticking with it matters most. Complexity has to earn its seat.
Question Four: Are You Following Evidence or Recent Performance?
When something has been winning, we assume it will keep winning. When it has been disappointing, we assume it is broken. Both instincts produce the same mistake: buying what is already popular and selling what is currently lagging.
Even in a world with a lot of luck, somebody will always look like a genius. If there are a thousand funds and strategies in the market, a handful will have a spectacular three-year run by chance alone. Those are the funds that end up in headlines, podcasts, and pitch decks. The winners are the ones you are shown.
Base rates push back against that. A base rate is simply the long-run record for this type of investment.
Good Investing is Not About Always Being Right
Before adding anything to your portfolio, ask four questions: Where should the return come from? What does this actually add? Is the complexity worth it? And am I following evidence, or chasing what has worked lately?
Good investing is not about always being right. It is about making decisions you can live with and sticking with them long enough for the odds to matter.
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