Nassim Nicholas Taleb refers to a structure that he calls “The Ludic Fallacy.” Essentially, statistics that are artificially confined or confined by specific rules. Game-like statistics.
The real world does not have limits that create simple decisions. If I toss a coin, I get heads or tails and the analysis of the results will follow a simple set of rules. If I see some highly improbable result, like 20 heads in a row, I might be smarter to examine the coin than bet that the odds on the next toss are 50-50. You should not blindly accept a given paradigm if the observations are so improbable as to deny your reality.
In a similar way people adopt as true and therefore certain, things that are a not quite 100% certain. Things like, inflation must happen because the Fed printed all that money, or Britain is in great trouble because of Brexit, or deficits don’t matter, or the price of real estate always goes up, and a thousand more. The real world is complex. People get into trouble when they believe things are 100% certain when they are even slightly less than 100% certain.
Suppose I am playing poker and I have a hand with four aces. I am nearly certain to win. Should I bet everything I own and can borrow on this hand? Probably not. Very high probabilities are not certainties. The problem with situations like this in poker and in life, is that they do not always win. As every poker player has been shown at one time or another, the second best hand is the expensive one. The eighth best hand costs nearly nothing.
Investors who believe they know all they need to know are subject to the same sort of catastrophe. If you believe in certainty you will eventually come to a position summarized by Jim Ling’s famous thought. “I was right twelve times and only wrong once.”
Every successful investor that I know is either humble or easily frightened. I know no one who would invest more than a small fraction of their net worth in a single idea, no matter how appealing the odds look. Wayne Gretzky has said he will never invest more than 10% of his family’s net worth in a single position. The thing people must learn is that all or nothing is an undesirable choice. Protecting the downside is at least as important as finding a big win.
Probably more important.
Repeatable success creates very large numbers. Saving $5,000 per year for 45 years invested at 10% is $3.6 million. Doing the same thing at 30%, but with a total loss after 30 years provides just $840,000. 10% investments are easier to find than 30% investments.
Playing the all-in game is wrong. Even the smartest and best-informed people lose sometimes. The world is complex and it not only has more variables than you know, but it is continually creating new variables and new connections.
100% certain eventually leads to a 100% certain loss.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. email@example.com 866-285-7772