The Importance of Skepticism in Investing

Skepticism is about approaching the world by asking why things might not be true rather than why they are true.

Annie Duke, Thinking in Bets

Optimism as Our Default

We are unabashed long-term optimists. The track record of human ingenuity and the capacity of well-run companies to create value over time are unmatched. Progress compounds, and owning durable, competitively advantaged businesses remains one of the best ways to participate in that progress over time.

Optimism, however, works best when it’s grounded in reason. Blind optimism is not a strategy – it is a hope, and it can be hazardous to your wealth. That is why a steady, healthy skepticism always has been, and always will be, a critical part of our investment process.

Skepticism helps us test stories against facts, ask what has to go right and ensure we are being paid appropriately for the risks we are taking. In short, optimism sets our destination while skepticism keeps us safely on the road.

Skepticism, Not Cynicism

When we say skepticism, we don’t mean cynicism. Skepticism is a posture of testing, not dismissing. Cynicism shrugs at evidence; skepticism engages with it. In practice, this means a clear-eyed willingness to ask probing questions before acting: What must go right? What could go wrong? What are the reasonable ranges of outcomes, and can we live with the bad ones?

In fact, the word skepticism originates from the Greek skepsis, which means “inquiry.” The idea of inquiry is not a wholesale rejection of an idea, but instead it is a criti cal investigation of whether a claim is supported by sufficient evidence. We take this idea of inquiry to heart through our research process as we try to stay grounded in discoverable and knowable facts, not emotion or narratives. We must always strike a balance between open-mindedness and reasonable skepticism.

Humility Over Hubris

As we often say, the future is unknowable. There are a wide range of potential outcomes in markets and in individual businesses, most of which are beyond anyone’s ability to forecast with precision. Because of this, it’s important to be realistic about what can and cannot be known in advance, and to remain open to many possible future paths.

Humility is the practical partner to skepticism. It keeps us from overweighting any single narrative and fights against the development of overconfidence. Based on our study of history, we know that progress and markets do not move forward in a straight line, and we build portfolios to withstand that reality.

Areas of Elevated Optimism

Howard Marks, Co-Chairman of Oaktree Capital, often notes that the market oscillates between optimism and pessimism over time like a pendulum, and that “the riskiest thing in the world is the widespread belief that there’s no risk.” While we don’t know exactly where the pendulum rests today, we do see pockets of elevated optimism and even speculation.

A powerful narrative around artificial intelligence is creating grand visions of the future. Businesses that enable, deliver or benefit from AI are viewed extremely favorably, and some investors are clamoring to participate with little regard to price or valuation. We believe the promise of AI is exciting and will bring many benefits, including some that are hard to imagine today. However, we must balance this optimistic narrative with reason, facts, and price discipline.

Beyond AI, speculative activity looks to be on the rise in general. Examples include hot initial public offerings (IPOs), the resurgence of “meme stocks” and special purpose acquisition companies (SPACs), the broadening of involvement in crypto, the aggressive use of margin debt, and the enthusiasm for risky endeavors like day-trading, short-term options, and leveraged single stock ETFs. In these narrow areas, there is a lack of skepticism, and the thought of downside risk seems nonexistent.

Importantly, higher stock prices and pockets of exuberance don’t require a bad ending – they simply imply that forward returns in these segments may be more modest and that the margin of safety can be thinner. In such backdrops, we must remain grounded in our investment process that has withstood the test of time over the past 30 years.

What We Won’t Do

We often lay out our investment philosophy and process by describing what we aim to do: Think like a long-term business owner; identify durable, high‑quality businesses run by talented CEOs; and purchase those at sensible prices with the intention of holding them for many years to let compounding do its work. However, it can also be helpful to invert this structure and frame our process in terms of what we actively avoid:

• We won’t compromise on our three-legged stool – business quality, management quality, or price discipline.
• We won’t abandon skepticism just because the backdrop feels benign or a popular narrative takes hold; alternatively, we won’t be blind skeptics just for the sake of it.
• We won’t make decisions based on hunches or flowery projections instead of well‑thought‑out reason and facts.
• We won’t try to predict the future, instead preparing for a range of possible outcomes.
• We won’t participate in speculative activity.

These are not acts of caution for their own sake. They are the preconditions for participating confidently in the upside of capitalism and business growth while attempting to protect against outcomes that permanently impair capital.

Preparation Over Prediction

The future will continue to surprise us. As Daniel Kahneman said in his book Thinking, Fast and Slow, “The correct lesson to learn from surprises is that the world is surprising.” Sometimes those surprises are pleasant, and sometimes they are unpleasant.

It is not our mission to predict these surprises – we can’t, and we don’t think others can make these predictions consistently and accurately either. Instead, we focus on preparation: doing rigorous research, asking hard questions, insisting on quality and price discipline, and keeping an open mind. This way, we feel we are prepared for whatever the future might hold.

Even in an environment characterized by elevated optimism in some areas, we continue to find and patiently pursue opportunities to own durable, cash‑generative businesses at sensible valuations – businesses we can own for many years and allow compounding to work its magic. The work continues day in and day out, no matter the external environment.

Thank you for your partnership and for allowing Baird Trust to be a steward of your capital. We remain focused on careful research, sound reasoning, and prudent portfolio management in pursuit of our ultimate goal: compounding your wealth for decades to come.

Baird Trust Company (“Baird Trust”), a Kentucky state chartered trust company, is owned by Baird Financial Corporation (“BFC”). It is affiliated with Robert W. Baird & Co. Incorporated (“Baird”), (an SEC-registered broker-dealer and investment advisor), and other operating businesses owned by BFC. The information offered is provided to you for informational purposes only. Neither Baird nor Baird Trust is a legal or tax services provider and you are strongly encouraged to seek the advice of the appropriate professional advisors before taking any action. The information reflected on this page is subject to change. The information provided here has not taken into consideration the investment goals or needs of any specific investor. Investors should not make any investment decisions based solely on this information. Past performance is not a guarantee of future results. All investments have some level of risk, and investors have different time horizons, goals and risk tolerances, so speak to your Baird Financial Advisor or a member of your Baird Trust team before taking action.