Saturday, February 6, 2016

Luck Never Gives

Luck never gives; it only lends.
Swedish Proverb

I am writing this the day before the Super Bowl. Yesterday I looked at the odds. The line is 3.5 points. If you think the Panthers are going to win the game, you need to give the other side 3.5 points. The over/under, the total number of points scored in the game was set at 44.5. This means if you think more than 44.5 points will be scored by both teams you bet the over; if less, you bet the under. The Las Vegas line is the combined wisdom of every gambler on the planet. The casino sets the line so that exactly the same amount of money is placed on both outcomes. The casino knows that the outcome of any given football game is a combination of both luck and skill. They aren’t interested in betting their money on anything like a football game. They are content to let you bet your money, then take 10% of the winner’s share from you or the other guy. They aren’t interested in the outcome of the game.

A particular gambler may get on a hot streak and consistently beat the line for a year or two, but eventually his results will revert to the mean. This is also true for money managers. A fund manager may beat the major stock indices for ten or maybe even fifteen years. However, sooner or later his results will revert to the mean. In this case that would be the appropriate stock index. Actually, it is worse than that. As an open fund grows, it holds more and more positions in more and more different investments, until it becomes an index.

Now skill is very important. There are brilliant investors like Warren Buffet, but even the sage of Omaha has been less than perfect over the last few years. It could be his mind is not as sharp now that he is in his eighties as it was in his forties, or it just could be that Berkshire Hathaway is such monstrously large and diversified conglomerate that it is starting to revert to the mean.

So what is the best we can do given that we don’t control the universe?

I am a great believer in luck, and I find the harder I work, the more I have of it.”
Attributed to Thomas Jefferson

My father worked as a chemist for fifty five years. His consistent performance earned him an enviable reputation for technical excellence and technical integrity. However, he never hit the big time, because none of his projects turned out to be gigantic winners. Research and Development is like that. For every ten good ideas that are tried out in the laboratory, one makes it to the prototype phase. For every ten prototypes, one makes it to production. For every ten products, one will hit the big time. Then, when he was in his early 60s, he was working on alternatives methods for bleaching paper pulp. Right when the Government was in the process of outlawing the chlorine bleaching agents used by paper industry, my father and his team was putting the finishing touches on hydrogen peroxide based alternatives. At age 64 his career took off like a rocket. For the next twelve years, he traveled all over the world teaching factory managers how to use these new products. During this time he won a number of prestigious international awards for his work in this field. He earned considerably more money than at any time in his life.

Was it luck? Yes. Was it skill? Yes.

We basically live in a cause and effect universe that has been corrupted by the fall. Certain types of behaviors greatly increase your chances for success. Consistently practicing these behaviors over long periods of time will begin chaining probability in your favor. Even if you find yourself reverting to the mean, you are at the mean of a much higher level group of individuals. Michael Jordan was born with talent. However, he also outworked his competition on a consistent basis. While Jordan’s work ethic in practice is well known, I am also willing to bet he spent a lot of time studying the competition. That’s what great athletes do in their spare time. Even though they understand that age will eventually cause them to revert to the means of their professions, they do not intend to go gentle into that good night.

Go thou and do likewise.

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