Saturday Serendipity
Quote, Mental Model, Twitter Thread.
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Quote
“We are what our thoughts have made us; so take care about what you think. Words are secondary. Thoughts live; they travel far. ”
― Swami Vivekananda
Mental Model
Mean Reversion
Mean reversion is when in a normally distributed system, long deviations from the average will tend to return to that average with an increasing number of observations. If I were to put it more simply I would say everything over the long term tends to go towards the mean/average.
I see this concept as similar to a pendulum swing where it sways from side to side but in the end, comes back to the middle.
In Life
This concept can be easily applied to any aspect of life. Let’s look at me, I am an average student who gets a grade of around 65-70% on average. There will be some days when I end up getting around 40-50 and some days I might get somewhere around 80-90. Yet on average, I am still an average student but when I do get an 80-90 people might overestimate my ability and eventually when I return to the average they will be disappointed.
Virat Kohli had a bad patch of form for a while and everyone thought he was finished and that he would never be able to play well again. What happened though he took his time and now he is back to how he plays normally.
To me, this smells like mean reversion.
In Investing
The general conception of the public when they buy a stock is to buy it when it is going up. They see the price of a company in the last few years going high and due to a multitude of reasons they put their money in that stock. And then more often than not the stock gives below-average returns. It’s the same with mutual funds you put money into a fund which has a past performance history which is above average but then in the end you get a below-average return.
“In stock market periods of above average performance are usually followed by below-average returns and periods of below average performance are typically followed by above average returns.”- Vishal Khandelwal’s blog
There are a few problems with mean reversion as well. I can identify two. One is that it is really hard to find out what the real mean is. The other is it is very hard to find out when something very far from the mean will revert back to its mean. The only antidote to these two problems, in my opinion, is looking at life through a bigger lens (larger sample size) and to look at the process over the outcome.
Conclusion
In life, I think everything in the end comes back to where it deserves to be. This is why the concept of mean reversion needs to be understood. Make sure you try and correlate this mental model with others because if you apply only this one you will be in a lot of trouble. It is very important to know how to use a mental model but just as important if not more to know how to NOT use it.
Twitter Thread
That’s it for this week! Hope you have a great weekend!