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"Fooled by Randomness"
I recently read “Fooled by Randomness”, the Hidden Role of Chance in Life and in the Markets, by Nassim Nicholas Taleb.
Within this work, and somewhat randomly, Taleb cautions, “A book review, good or bad, can be far more descriptive of the reviewer than informational about the book itself. “ To some, this point may be obvious, it would be very difficult to write about a book and remain so detached as to be 100% objective. Taleb enjoyed a “two decade career as a qualitative trader in N.Y. and London” and currently is the Dean’s Professor in the Sciences of Uncertainty at the Isenberg School of Management of the University of Massachusetts at Amherst. Many of the anecdotes he presents come from his experience with coworkers’ bad trades. Specifically those who ‘blew up’, trading and making money along the way until that one bad series of trades that end their career.
He offers a number of anecdotes about survivorship bias, a phenomenon whereby we attribute great skill to someone for his performance when in reality, randomness will produce money managers with 5-10 year winning streaks (beating the averages) in the same manner whereby if 10,000 people flipped a coin, half would get a head, then half of them would get a second head, and so on. After 10 flips, about one in 1024 flippers will have a run of ten heard in a row. Now, Taleb certainly has a good point here, but cannot explain how a Warren Buffet, who had that kind of streak by the late 80’s continued that streak another 17 years. (Or to put it another way, I used Taleb’s reasoning and did not buy Berkshire Hathaway in 1992. Since then it rose to 118.000, a return of nearly 19%/yr these past 15 years.)
He also offers an example of survivorship bias in discussing “The Millionaire Next Door.” TMND delivers a message that it’s possible to accumulate wealth by living a lifestyle beneath one’s means. A number of counter examples are offered as well. People with high incomes, moving into neighborhoods where they feel compelled to “keep up with the Joneses” and ultimately living a life of conspicuous consumption, but not saving. Taleb suggests the very way the authors went about their selection process ignored survivorship bias. What of the people who lived frugally, saving the suggested 10-15% of their income, and due to one of the standard disruptors (loss of job, divorce, injury, etc.) find themselves poor at age 62? I believe the lessons of TMND are still of value, and should not be so quickly dismissed. No one suggested that following its advice would make one immune from all tragedy. I dare say that if we took the proper samples as Taleb advises, we’d find some small percent of the group that spent more than they earned who still managed to be successful by that usual definition. (continued)