The Stockdale Paradox


Admiral James Stockdale was the highest-ranking American taken prisoner during the Vietnam War after his A-4 Skyhawk fighter was shot down over North Vietnam. Stockdale ejected, breaking a bone in his back. Upon landing in a remote village, he badly dislocated his knee, which subsequently went untreated. Shortly thereafter, he was captured by North Vietnamese forces.

The Stockdale Paradox
The Stockdale Paradox

Stockdale was imprisoned in the infamous “Hanoi Hilton” POW camp where he spent the next seven years in captivity. Despite being kept in solitary confinement for four years, in shackles for two years, physically tortured numerous times, denied medical care, and starved, Stockdale organized a system of resistance and developed a cohesive set of rules governing prisoner behavior. He had no set release date and no certainty as to whether he would even survive to see the next day.

Stockdale did survive.

Upon his release from the POW camp in 1973, Stockdale’s heroism became widely known, and he was awarded the Medal of Honor by President Gerald Ford in 1976. Years later, while being interviewed by Good to Great author Jim Collins, Admiral Stockdale illuminated a fascinating point that I think should resonate with anyone dealing with uncertainty and fear. I’ve copied the relevant portions of the interview below:

Admiral Stockdale: “I never lost faith in the end of the story. I never doubted not only that I would get out, but also that I would prevail in the end and turn the experience into the defining event of my life, which, in retrospect, I would not trade.”

Jim Collins: “Who didn’t make it out?”

Admiral Stockdale: “The optimists. Oh, they were the ones who said, ‘We’re going to be out by Christmas.’ And Christmas would come, and Christmas would go. Then they’d say, ‘We’re going to be out by Easter.’ And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart. This is a very important lesson. You must never confuse faith that you will prevail in the end—which you can never afford to lose—with the discipline to confront the most brutal facts of your current reality, whatever they might be.”

This dichotomy of accepting the brutal reality while also maintaining an everlasting flame of optimism is now known as the Stockdale Paradox.

Financial planning is the physical embodiment of the Stockdale Paradox. Save heavily and build a healthy cash cushion so your investable assets can compound over time. Paranoia over the short-term, optimism over the long-term. Does that sound familiar to today’s environment?

As Morgan Housel relates, “Optimism and pessimism can coexist. If you look hard enough, you’ll see them next to each other in virtually every successful company and successful career. They seem like opposites, but they work together to keep everything in balance.”

I think two vignettes from Jeff Bezos and Bill Gates illustrate this point perfectly. Jeff Bezos is an optimist. This view allowed him to dream up the business empire that he presided over. But in 1999 and early 2000, Amazon was still a fledgling online book seller. As 2000 dawned, Amazon’s stock peaked at $107.13 per share. When the bubble burst, Amazon fell to $5.97 a share. So how did Amazon survive the bust? Bezos and his CFO Warren Jenson craved a cash cushion. They believed in Amazon and thought they were laying the groundwork for a world changing idea; however, they also didn’t turn their backs to the excessive speculation and uncertainty of the day. They were optimists who still maintained a heathy dose of fear and weren’t blind to the reality around them.  

In February 2000, Amazon sold $672 million in convertible bonds to overseas investors. This time, with the stock market fluctuating and the global economy tipping into recession, the process wasn’t as easy as previous fundraising efforts had been. The deal was completed just a month before the crash of the market, after which it would have been nearly impossible to raise money to keep the company solvent. The cash cushion saved Amazon.

Bill Gates envisioned a world where everyone owned a desktop computer.

Even as he became America’s richest man in his thirties, Gates never stopped thinking about the day when his company might fail. Morgan Housel writes, “In 1995 he was asked by Charlie Rose why he kept so much cash on hand. Things change so fast in technology that next year’s business wasn’t guaranteed, he said, ‘Including Microsoft’s.’” In 2007 Gates reflected, “I was always worried because people who worked for me were older than me and had kids, and I always thought, ‘What if we don’t get paid, will I be able to meet the payroll?’”

From the day he started Microsoft he insisted on always having enough cash on hand to keep the company alive for 12 months with no revenue coming in. Envisioning a world intertwined with desktop computers: optimism. Maintaining enough cash to make payroll: fear.

It’s the Stockdale Paradox.

In our own planning doctrine, we encourage our clients to save aggressively, but to also be wildly optimistic about American business over the long-term. It takes guts to be an optimist. Progress compounds slowly and to such an extent that we often barely notice it. Setbacks can be sharp and terrifying, yet somehow, we usually rebuild and the compounding of progress continues. Investing comes down to surviving an inevitable chain of short-term setbacks to enjoy long-term progress and compounding.

Morgan Housel again writes “You can only be an optimist in the long run if you’re pessimistic enough to survive the short run… Acknowledge the cold statistics of how common bad news is. It’s common at the global, national, local, business, and personal level…So save money heavily, knowing with certainty that you’ll need a cushion to deal with the next banana peel. Be a little paranoid, knowing that the assumptions you hold today could break tomorrow, and you’ll need enough room for error to make it to the next round…Since progress is cumulative (we don’t forget past innovations) but setbacks are temporary (we rebuild), the long-term odds tilt towards growth. The economy is no different. As long as more people try to get better than screw up, the long-term odds are in an economy’s favor. And that’s almost always the case, because the screw-ups — the declines, the recessions, the wars — fuel the problem-solving. Once the odds are in your favor, compounding takes hold… If the odds are in your favor, and you can keep them in your favor for a long time, you shouldn’t just be an optimist. You should be a ridiculous, full-blown, giddy optimistic.”

Invest like an optimist, but never lose that healthy dose of fear.

Dylan Potter

Dylan is a partner, Vice President and Wealth Manager at Howe & Rusling.


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