Saturday Serendipity
Quote, Mental Model, Interesting find.
Quote
“Doctors won’t make you healthy. Nutritionists won’t make you slim. Teachers won’t make you smart. Gurus won’t make you calm. Mentors won’t make you rich. Trainers won’t make you fit. Ultimately, you have to take responsibility. Save yourself.”~ Almanack of Naval Ravikant
Mental Model
Pari-Mutuel system
A pari-mutuel system is a system where you play against someone. Let me explain it in a simpler way. When you are betting on a horse race are you betting against the house or are you betting against the person who bet on the other horse?
Most think it is the house but reality is you bet against people who don’t bet on your horse. Safal Niveshak writes in his blog,
Let’s assume a hypothetical horse race with 5 horses where people can bet their money on their choice of horse. Following the start of the event, no more wagers are accepted. So here’s the distribution of money bet on each horse just before the race starts.
Horse 1: Rs. 20,000
Horse 2: Rs. 3,000
Horse 3: Rs. 2,000
Horse 4: Rs. 500
Horse 5: Rs. 4,500Thus, the total pool of money on the event is Rs. 30,000. Let’s say that horse-1 wins the race. The payout is now calculated. First the commission or the take for the house (company organising the race) is deducted from the pool. For example, with a commission rate of 15% the house keeps 30,000 x 15% = Rs. 4,500. This leaves a remaining amount of Rs. 25,500. This remaining amount in the pool is now distributed to those who bet their money on the winning horse i.e. horse-1. So people who bet their money on winning horse get 25,500 / 20,000 = 1.2 for each rupee wagered. Their payout ratio were 1.2. So the payout ratio for each horse is as follows –
Horse 1: 25,500 / 20,000 = 1.2
Horse 2: 25,500 / 3,000 = 8.5
Horse 3: 25,500 / 2,000 = 12.7
Horse 4: 25,500 / 500 = 51
Horse 5: 25,500 / 4,500 = 5.6This is a simplified example. In real-life horse racing the pool size often extends into millions of dollars with many different types of outcomes (winning horses) and complex commission calculations.
Relating investing and Pari-Mutuel system, Munger says –
To us, investing is the equivalent of going out and betting against the pari-mutuel system. We look for a horse with one chance in two of winning and which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.
Investing in a company which has better odds and can give you great returns is what you want. In investing terms you can call it a great company which is mispriced. This is possible due to the Pari-mutuel system of the stock market.
The big difference between the horse betting and the stock market is the commission of the house. So in the stock markets the commissions are low so even if the odds are not so favourable you can make decent money.
Conclusion
You can use pari-mutuel system to make decisions in the stock market and also realise that you don’t always make the right decisions and you don’t need to. You only need a few good ideas and keep consistent with your hard work. Buffett’s rule is one good idea per year.