Can We Expect To Get Lucky?

Somebody once said, “The moment I leave something on luck. It runs away.”

One thing that has always fascinated me is the way some people overemphasize the luck factor in life. I have thus for long tried to understand how important is the element of chance in achieving success.

Social Proof & Luck:

As often happens in the free market economy if there is a demand to be met, somehow it will be met. Thus the desire of the people to increase their probability of getting lucky has become a great market in India, at the least. The market comprises of astrologers mainly who always have reason for everything that has happened to you. I don’t know if that all works or not but I know for sure that people tend to overemphasize the utility of these things. This reminds me of a famous quote by J.K.Galbraith,

"This is a world inhabited not by people who have to be persuaded to believe but by people who want an excuse to believe."

Probability & Luck:

“Probability is omnipotent and omnipresent. It influences every coin at any time in any place, instantly. It cannot be shielded or altered. And probability is not limited to coins and dice and slot machines. Probability is the guiding force of everything in the universe, living or nonliving, near or far, big or small, now or anytime”—Scott Adams

I think that the above para explains pretty well the concept of luck which according to me is nothing but permutation and combination. And only if we can zoom out and see ourselves as the part of the ecosystem it will be apparent that we cannot by any means control the things happening around us all we can try and do is make the best use of the things around us. But the problem is that when things don’t go the way we expect them to go. We would say that ‘I did everything that needs to be done and yet things did not work out. Why?’ I think that the following quote explains it rather well that some things are unexplainable,

“Every other question has an answer to why. Only probability is inexplicable”—Scott Adams.

Investing & Luck:

“When we try to pick anything by itself, we find it hitched to everything else in the universe”—John Muir

I think once we start thinking of stock markets as an ecosystem we realize that there are lots of variables that can influence it. To add to it, we are not competent enough to understand and extrapolate all the variables into stock market reactions. There will always be this systematic risk which can work against us and sometimes for us.

Thus I think one of the most important thing in investing is to be in a position where we are not required to close a position because of financial need. And if we play the game long enough and diversify as we go along we can expect to achieve what we deserve.

“We might see randomness in the outcome of an individual coin toss, but as the number of tosses increases, probability has firm control of the outcome”—Scott Adams

Conclusion:

Human nature being what it is we tend to overestimate the influence luck or chance has on the outcome when something goes wrong. This might reduce dissonance for a while but the trade off is the state of psychological denial which is a big drag on understanding things the way they are. And few things are more important than understanding things as they are. Thus I think that the following advice from Charlie Munger is worth its weight in gold,

“Whenever you think that some situation or some person is ruining your life, it’s actually you who are ruining your life. It’s such a simple idea. Feeling like a victim is a perfectly disastrous way to make go through life. If you just take the attitude that however bad it is in anyway, it’s always your fault and you just fix it as best you can – the so-called “iron prescription” – I think that really works”

Take A Simple Idea & Take It Seriously

“Our ideas are so simple that people keep asking us for mysteries when all we have are the most elementary ideas”—Munger

While watching Memento I realized that a man with limited ability or cognitive tools can still accomplish otherwise seemingly impossible task if he somehow manages to create a system that serves as an antidote to the limitations. One good example can be the sign language that mute people use to interpret their thoughts with other people.

Much engrossed by this thought I started thinking, as an investor, about the importance of creating a system which not only incorporates proper checks and balances to take care of our limitations but also serve as a foundation to stick to the knitting. This post is a way of giving structure to such a system. The following are the important ideas that constitute the system so far.

Mental Models:
I think one of the major difficulties that we face as an individual is matching our actions with our notions. The reason I think is the dominance of cognition, which is situation dependent, over perception. And it is also true that cognition per se can be misleading at times because of the biases. This is where I think connecting reality with pre held notions (mental models) can help us extrapolate past and present in a better way. And once you start using mental tricks the system becomes that much more efficient.

“If you skillfully follow the multidisciplinary path, you will never wish to come back. It would be like cutting off your hands”—Munger.

I don’t know if I have been following the multidisciplinary path skillfully but it has been six months since I was introduced to mental models by Prof. Sanjay Bakshi and ever since I have not spent a day without thinking about mental models. It just becomes a part of what you are and it is fun, after all. For ex:

“He’s the best physician that knows the worthlessness of most medicines”—Ben Franklin. (Backward thinking/reductionism)

Opportunity Cost:
“Opportunity cost is a huge filter in life. If you’ve got two suitors who are really eager to have you and one is way the hell better than the other, you do not have to spend much time with the other. And that’s the way we filter out buying opportunities”—Munger.

Life is all about making choices. Right from buying a shoe to buying a stock everything boils down to opportunity cost. It so happens that the next best alternate foregone becomes a sort of hurdle rate. For example consider the opportunity cost of getting married. The hurdle rate in this case is sacrificing half your bed (just that?). Now if the person who occupies the other half is worth more or less dependents on the choice one makes—choosing your spouse. Many a times I have seen people who some where down the heart feel that half a bed is worth more than the spouse! But taking steps accordingly can be cited as similar to selling a stock that has lost 90% of its value. So one ends up becoming a rationalizing animal. This reminds me of the following quote by Ben Franklin,

“Keep your eyes wide open before marriage, half shut afterwards”

Compound Interest:
“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things”—Munger.

By understanding this simple idea one can realize that it is not necessary to do extraordinary things to become successful, just doing good enough over the long run will lead to that end. Having said that we should also realize that there will always be people who will do better than us. Instead of getting envied we should only acknowledge their work and try and learn something from them. In short if one is trying to increase his productivity per hour one should not wonder at somebody else doing better than him but instead learn something from him. The time wasted wondering comes at a cost and it of course will reduce the productivity per hour. Mankiw said in ‘Principles of Economics’ that wealthy nations have better productivity per hour as compared to poorer natoins. The same is the case with wealthy individuals as compared to poorer ones, I think.

It’s not a one way road to Rome:
“What you learn in adversity—no university can teach you”—Imran Khan.

Here I would like to bring in one of the properties of cause and effect, “Cause and effect can be widely separated in time and space.” Thus if we can somehow keep on doing what we ought to do irrespective of all the hurdles that come along the way we will somehow reach our goal. This is my belief in the power of the simple law of cause and effect stated above, nothing higher than that.

Circle of Competence:
“I’m no genius, I’m smart in spots, and stay around those spots”—Thomas Watson Sr.

I think most of us have problem realizing our circle of competence because human nature being what it is, we tend to overestimate our capability and undermine the capability of others. But once we approach somebody who has something good by asking, ‘why is he better than the most of us?’ we stand the chance of not only learning great many things but also better realize our limitations. And working backwards from our limitations we can easily sort out the better qualities in us.

“The name of the game is continuing to learn. Even if you’re very well trained and have some natural aptitude, you still need to keep learning”—Munger.

A small leak can sink a great ship:
Somebody once said, “A chain is as strong as its weakest link.”

Just as a value investor looks for opportunities which have very low downside risk, we should not allow any characteristic in our system that can act against other powerful ideas. This variable can be our attitude or some kind of addiction.

Conclusion:
When we start thinking of our environment as a system we realize that we are nothing but a variable of that system. It is this collection of variables that make that system possible but malfunctioning of one particular variable will have no or little effect on the system. Similarly, our system is designed to operate in a much larger system. What makes our system efficient is the power our system can absorb from the much larger space. For example, an investor cannot hope to realize the fruits of compound interest without acknowledging the way stock markets work. Thus we should be ready to make changes as things change around us.

“Those who will not face improvements because they are changes will face changes that are not improvements”—some Victorian minister.