HOW LUCK AND RISK WORK
Knowing the high odds of something happening loses its meaning when that thing happening hurts. Probability goes out the window. Odds that are in your favor but still hurt are hard to distinguish from odds that aren’t in your favor.
Capital Thinking • Issue #606 • View online
The idea that something can be likely and not happen, or unlikely and still happen, is one of the world’s most important tricks.
Outcomes are a mix of skill and luck. Persistence is a measure of skill: coaches making the playoffs, sales staff hitting targets, or personalities in the news. Skills are things which can – and should – be controlled.
But sometimes life is luck too.
Why We’re Blind to Probability
Morgan Housel | The Collaborative Fund Blog:
But let me tell you about a common problem. I’m as guilty of it as anyone else.
It’s that most people understand probability, but few actually believe in it.
Most people get that certainties are rare, and the best you can do is make decisions where the odds are in your favor.
They understand you can be smart and end up wrong, or dumb and end up right, because that’s how luck and risk work.
But almost no one actually uses probability in the real world, especially when judging others’ success.
Most of what people care about is, “Were you right or wrong?”
Probability is about nuance and gradation. But in the real world people pay attention to black and white.
If you said something will happen and it happens, you were right.
If you said it will happen and it doesn’t, you’re wrong.
That’s how people think, because it doesn’t take much effort to think it.
This happens during elections. Nate Silver can say there’s a 72% chance Hillary Clinton will win. Then when Donald Trump wins people say, “Nate Silver was wrong.”
It happens during pandemics.
A headline might say, “Experts predict 200,000 deaths by August.”
What it should say is, “Experts have 95% confidence that the number of deaths by August will be between 110,000 and 290,000,” or something like that.
But if the number of deaths by August turns out to be, say, 120,000, people will declare the experts wrong. If the number turns out to be 350,000 they will be called disastrously wrong – even though the forecasters knew there was a one-in-twenty chance of that occurring.
It happens in investing.
Predictions that come true bring invitations to be on CNBC. Predictions that don’t bring client redemptions. Black and white.
We can’t just say this happens because people are dumb or lazy. Probability gets ignored for three reasons.
*Featured post photo by Jarosław Kwoczała on Unsplash