Let’s say you sponsor a contest to determine the “world’s best coin flippers.” About 100,000 people from across the world come together to participate in this contest. Everyone flips a coin at the same time.
After each coin flip, those who flip “tails” must leave, until the only people left have flipped 10 consecutive heads. Basic statistics suggests that we could expect about 98 coin flippers to remain at the end of the contest.
The odds of flipping heads 10 times in a row are 1/2^10 = 1/1024. So, for 100,000 participants, there will be 100,000/1,024 = 98 people who would have flipped 10 consecutive heads.
Then, these 98 “skilled” coin flippers would get thousands of likes on Facebook, and followers on Twitter. Those with the best smile and social media skills will write bestselling books about coin flipping, sharing their secrets of how to become a world-class coin flipper.
Anyways, let’s now consider investing. If just 50% investors outperform the stock market every year, the odds of one investor outperforming every year for 10 years would be 1/1024. That is, just one out of 1,024 investors would achieve this feat of outperforming the market every year for 10 years.
If just 30% investors outperform every year, in 10 years we will have just one out of 169,351 investors achieving this remarkable feat.
Idea Source: Michael Mauboussin’s More Than You Know
India currently has around 25 million (2.5 crore) demat accounts, and around 30% of these are active. So India has around 7.5 million people active in the stock market. Assuming 98% of these are short-termers, traders, speculators, etc. we are left with around 0.15 million or 150,000 people who are genuine long-term investors (which itself sounds a big number).
Now if 50% of these 150,000 ‘investors’ who stay invested in the stock market for the next 10 years outperform every year, we will have 146 of them who would outperform every year for 10 years (150,000/1,024). And if 30% of these people outperform every year, we will not have even one investor (150,000/169,351) who would outperform all 10 years.
Please note that what I am talking about here are just odds or probabilities based on mathematical calculations. But that is what investing is all about – probabilities, not certainties.
Sadly, most of us most of the times judge the quality of our decisions and actions by one single factor, and that is our one-off good performance that comes easy and at the very beginning of our endeavour.
Whether we are talking about a ravishing startup entrepreneur who made his first billion in the very first year or a new, aggressive sportsman who is all set to destroy his experienced opponents, we often completely ignore probabilities of successes across fields.
Investing is not any different. As investors, we often struggle with judging whether a decision was good or not, even in hindsight, because like the winning coin flippers we often only look at the outcome and not the process.
The truth, however, is that a good process is the only thing that could help you bring the odds of success in your favour. It’s only with a good process that you stand a chance to do well in investing over the long run, irrespective of the fact that you may not be among those 146 “greats” who will outperform the market every year for the next 10 years, and then not attribute any of their success to luck.
You see, most people who start their careers – in investing or outside of it – and achieve great success in quick time often ignore that being successful at the beginning has the danger of blinding them to the opportunity to get really good instead of merely coasting.
Ironically, that’s what early success does to our brain. It gives us a dopamine kick with every good outcome. We feel (over)confident of repeating our success because we completely ignore the role of luck. We fail to work on our process. And we end up with great disappointment.
There is nothing sadder than the self-limiting arrogance of the confusion between lucky and good. Because like the “world class coin flipper,” it leads us to go about our investing lives with brashness as if our early success was a creation of our skill, not luck.
A consequence of confusing being good for being lucky is that investors tend to think it’s easy to be a successful investor. The ultra-successful, even though they are few, have an outsized effect on us. We believe we can succeed because they did.
This tendency to base decisions on observed success, while ignoring unobserved failure, is called the survivorship bias. Lotteries exploit the survivorship bias to rake in billions. Lottery ticket buyers are motivated by the stories of the few jackpot winners who become instant millionaires. The millions of ticket buyers who never win receive little attention.
We are in a bull market, so please beware of that confusion between being good versus being lucky and the resulting arrogance that comes from completely attributing your success to skill than luck.
More than that, please beware of stories of investors and money managers who proclaim to have understood the secret of beating the market all the time. They probably have never known the odds of continued success in a probabilistic field like investing.
The world of investing, like most things in life, produces success stories and failures. It’s human nature to wish to copy success. However, an ironic truth is this: To accept success, and especially quick success at face value without acknowledging the role of luck is a strategy for failure.
More Than You Know by Michael Mauboussin
The Success Equation by Michael Mauboussin
Nice post Sir. Just wondering, although above probabilities are right, Does investor needs to outperform market every year? There should be some investors who will outperform the market at the END of the 10th year who haven’t outperformed few years in those 10 years.
It looks like we are going by an average in above post. Is that correct ?
Very interesting read Vishal.
One question regarding -“Assuming 98% of these are short-termers, traders, speculators”
Where can we get this figure from. I feel little incredulous, considering that so many ppl are going MF way (record SIP inflows). How can only 2% ppl be mainly responsible for that deluge
This is a very interesting post. Can your logic be applied to success as well? What I mean is that can we say Warren Buffet has also been plain lucky or that he is the 1 guy from the 15th row of your table?