Posts filed under “Philosophy”

Possible versus Probable

Its Friday, and has become my wont, this is the day of the week I like to kick back, wax philosophical about various thoughts kicking about me noggin.

One of the things that I have been noticing of late is the way so many people seem to confuse facts with forecasts. Twitter is rife with this issue, as 140 characters plus a dearth of actual thinking turns out to be a bad combination.

Where I see this more than anywhere else in the investing world is the significant confusion between Possibility and Probability.

Stated differently, more than a few investors are lumping all of the non-zero probabilities together as one similar trade. They are not, for reasons I shall soon make clear, the same thing. This has been true with many people, from Pension fund managers down to mom & pop investors.

Let’s define the terms Possible and Probable so that we all begin with the same basic understanding of these words. Something that is Possible may — or may not — come to be. There is no statistical insight provided, it is merely an outcome that may or may not come to pass. It is possible that you could get hit by lightning, or win the lottery, or marry a supermodel. When we describe something as possible, we mean there is a non-zero likelihood of that outcome — it could happen; we just don’t know if it will or will not, but it might.

What seems to confuse investors about possible is the statistical likelihood of occurrence. Can a company on the verge of bankruptcy go on to become the biggest company in the world? It is possible — and Apple (AAPL) did just that over the course of a 15 year from 1998-2012. But think about all of the many tens of thousands of companies that have been on the verge of going belly up. Is it possible that they could do the same? Well, the answer is Yes, it is theoretically possible — but not very probable. And indeed, experience teaches us that most insolvent and near insolvent firms actually do go bankrupt eventually.

Probability is a the term for the branch of statistics dealing with chance and outcome.

Possibility is binary — can this happen or not?

Probable is more nuanced mathematics — there is a n% chance of a given outcome, where n = a number between 0-100.

Anything that is Probable must by definition be Possible; However, not everything that is Possible is going to be Probable.

And therein lay the rub.

Lately, I have seen this error come up in two areas — long term Pension Funds, and Venture Capital. The most common mistake is to conflate the two — mistake what is possible for something that is probable.

With Pension Funds, we have an issue of national import in that many of these defined benefit plans are significantly underfunded. To catch up, some of these have been directed to add more Hedge Fund exposure. There is an accounting reason — but not a good investing reason — for this based on idea of expected returns. While the tiny minority of funds that create Alpha means that there exists a theoretical possibility for Hedgies to help pension funds make up their shortfalls, the high fees and under-performance makes it rather improbable that this will occur. This is to say nothing of the long odds that Pension funds will pick the next Ray Dalio or Jim Simons.

Hence, the possibility of better performance perversely leads to the probability of worse performance.

In Venture Investing, the dream of 100X returns is the tantalizing possibility that keeps investors coming back to the VCs — despite the very long odds that your fund will find the next Instagram. The poor track record of the past decade, the limited ability to select VCs that will outperform, means that the dream is a possibility, but the odds are improbable.

Whenever asked about Angel or Venture investing, I say the same thing: Assume it goes to zero. That is the highest probability, most likely outcome. Invest no more money than what you are comfortable lighting up in flames (i.e., going to nothing).

Who should focus on the Possible? Writers, dreamers, artists, futurists, designers, technologists, entrepreneurs — the people who imagine the future. Nothing I wrote here should discourage any of these sorts of folks from pushing for the possible, (however improbable). It is how nearly all of human progress has been made, pursuing the improbable.

For investors, however, you are best served by sticking with the Probable. Understanding the difference will save you a lot of capital over the long run.

Category: Hedge Funds, Investing, Mathematics, Philosophy, Venture Capital

QOTD: The Market Giveth . . .

Here is my market quote for today, from MacroMan:   “The Market giveth and the Market inserts red hot pokers before dicing you into small chunks and spreading your remains to the four corners of the earth.”   That’s a bit more severe than “and the market taketh away,” but certainly makes a noteworthy point…Read More

Category: Philosophy, Psychology, Trading

Resigning from the Professional Undertaking of Coin Flipping

I love this quote that manages to combine elements of Uncertainty, Existentialism and Agnosticism:   “I have resigned from the professional undertaking of coin flipping. I am not here to tell you where golds gonna be. I have no idea. That’s my existentialism. I am a student of uncertainty. I have no idea where the…Read More

Category: Investing, Philosophy

Sales Training Versus Mentoring/Industry Knowledge

Its a steamy summer Friday, I got home very late last night, so this morning’s Friday philosophy will be brief: I keep reading about graduates trying to get into Wall Street training programs. I suspect most people do not understand what this means. A brief explanatory: For the new rank and file hires at the…Read More

Category: Apprenticed Investor, Philosophy

David Foster Wallace: This is Water

In 2005, author David Foster Wallace was asked to give the commencement address to the 2005 graduating class of Kenyon College. However, the resulting speech didn’t become widely known until 3 years later, after his tragic death. It is, without a doubt, some of the best life advice we’ve ever come across, and perhaps the most simple and elegant explanation of the real value of education.

THIS IS WATER – By David Foster Wallace from The Glossary on Vimeo.

We made this video, built around an abridged version of the original audio recording, with the hopes that the core message of the speech could reach a wider audience who might not have otherwise been interested.

Category: Philosophy, Video

Steve Jobs 2005 Stanford Commencement Address

Drawing from some of the most pivotal points in his life, Steve Jobs, chief executive officer and co-founder of Apple Computer and of Pixar Animation Studios, urged graduates to pursue their dreams and see the opportunities in life’s setbacks — including death itself — at the university’s 114th Commencement on June 12, 2005.

Transcript of Steve Jobs’ address:

http://news-service.stanford.edu/news…

Stanford University channel on YouTube:

http://www.youtube.com/stanford

Category: Philosophy, Video

The Cave: Plato’s Allegory in Claymation

This is a wonderful clay animation adaptation of Plato’s Allegory of the Cave, which dovetails nicely into my Decline of America piece posted yesterday. The video demonstrates simply and briefly how our decline is probable but preventable.

Read More

Category: Philosophy, Video

America’s Inevitable, Yet Preventable, Decline

“It is no measure of health to be well-adjusted to a sick society.” ~ Jiddu Krishnamurti Much has been said on the topic of America’s rise and its inevitable, although preventable, decline. But most of what has been said or written uses empirical evidence, specifically historical observations, of the rise and fall of empires, most…Read More

Category: Philosophy, Think Tank

QOTD: 8,000 Points Later . . .

Josh calls out those who have dug their heels in and fought the tape the whole way up. Are these folks part of your daily media diet? He notes: “Some people need to reflect back on what they’ve been doing for the last 8,000 points. Others need to reconsider whom they’ve been listening to and…Read More

Category: Philosophy, Really, really bad calls

Where Is ‘the Party’ Now?

Nobody goes there anymore. It’s too crowded. ~ Yogi Berra As a philosopher-type, I like to use metaphors; they can be effective in painting an abstract picture that enables universal understanding. But metaphors can also provide a means to concrete translation for the individual. In a non-philosophical description, metaphors can be instructive and entertaining. So…Read More

Category: Philosophy, Psychology, Think Tank