Saturday Serendipity
Quote, Mental Model, Interesting find.
Hello.
Reading time: About 6 minutes
Quote
“All of the history of humankind is a short chapter in the history of biology. And all of biology is a short chapter in the history of the planet. And the planet is a short chapter in the history of the universe.”—Will and Ariel Durant
Mental Model
Law of small numbers
Have you ever met a person who comes and tells you that this exercise, drink, food, etc. will change your life?
Let’s call the person that give these combinations of food and exercises Aayush. He calls it a ‘superfood’ or an unconventional exercise which he says is the best exercise out there.
He say’s all of these out of his personal experiences. He says that he has had this ‘superfood’ and did this exercise to become a superhuman who is now very productive. This all can be true. Now he might even say that he tried all of this for his family. Their families also became healthier and more energetic.
Most likely you would listen to Aayush’s recommendation.
What happens if you try it out?
Sadly it did not work out for you. You felt the same as you always do.
What happened?
The problem with Aayush’s superfood or unconventional exercise is actually quite obvious and easy. Aayush just tested his ‘superfood’ and unconventional exercise with his family who have similar genetics and at the same time are very few in terms of ‘sample size’ if you want to actually generalise it and prove that it works.
Similar things happen when you see a few smokers who are old and fit. Infact I have a great example in mind. The Oracle Of Omaha. He drinks a lot of coke. Now we should follow Buffett in a lot of things and take his advise on a lot of things his diet is not one of them. He is one of a kind. If you have a diet like that the odds of you even being alive at 65 is very low. His diet is sustainable for him maybe because of his genetics and the fact that he does not have a lot of stress. (note: i don’t know how his body is coping with it)
But if a person comes up and says it is fine to drink six cans of coke because Buffett drinks those many everyday and is still fit and energetic, that person is nothing less than stupid!
This is known as survivorship bias as well. Where you don’t look at the majority but only see the small samples that are available to them. (Availability and survivorship bias overlap)
According to Daniel Kahneman and Amos Tversky the law of small numbers is also known as insensitivity to sample size.
This law is applicable to everything. The law of small numbers basically says that the sample size that you have is small and it shapes your view on all the people. The examples I have given above are a bit extreme as the sample size is only one but it still stands true. For example if you take a sample size of 50 people and say that six out of ten people like to use a certain brand of toothpaste. People will assume that they have actually taken they survey of the entire nation, this makes them feel FOMO and social proof makes them purchase that toothpaste.
So what happens is the small sample size makes us feel like it applies to everyone. While this is not true at all.
In Sports
The same law applies to sports as well. Let’s take a simple example of a player like Suryakumar Yadav. You see the way he plays and you conclude that even you can hit a shot like him. In fact many players in the game have started playing those shots behind fine leg.
Now the sample size of the players who can play those shots effectively are very less. So you should not assume that you can play that shot. It takes a lot of effort to play it as effortlessly as Surya.
In Investing
In investing as well the small samples are taken as general consensus. We see the fund manager’s returns over the short term such as a year or two years, and then we call them great or bad. But if we simply wait and see the long term we find out that most professionals don’t beat the index. To generate superior returns over a long period is very hard and that is the true test of an investor.
Many brokers and investors say that their recent investments have doubled in no time, or they got a lot of multi baggers in a bull run, or they have beaten the index for the year by a lot of points, etc. these things that brokers and investors say make them sound very smart and fool investors like us. They law of small numbers can come to the rescue if we want to be saved from the people who manage or influence our decisions.
Even for companies. The bad ones might have a certain period of boom or cyclical benefits which makes them earn a little bit of extra profit in the short term at the cost of the long term. It is important to ensure your company is not like this.
Antidote
Safal niveshak writes,
“It’s important to understand the context or circumstance where this fallacy becomes more pronounced. Let me use an example to explain my point
.
If you were observing Michael Phelps, the swimming legend, compete against few amateur swimmers, even few observations would be enough to make a generalization about future outcomes of such competitive events i.e., Michael Phelps will trounce each one of them every single time. Here you don’t need to worry about the law of small numbers. Why?
The answer lies in understanding the role of skill and luck in any activity.
The magnitude of the fallacy grows larger as the luck-to-skill ratio rises. Be it sports or investing, a lot in our life is governed by luck. Certain games (cricket or poker) have higher element of luck and some are completely devoid of luck (chess or swimming).
So an amateur player can win a game of poker a few times just because of luck, but over a longer period of time i.e., over a large number of hands played, the luck evens out and skill prevails.
A corollary to our law of small numbers would be – over short periods of time, luck is more important than skill. The more luck contributes to the outcome, the larger the sample you’ll need to distinguish between someone’s skill and pure chance.
For that matter, how do you determine if an activity is ruled by luck or pure skill?”
Moubassin writes that if you can lose on purpose then it is most likely a skill. If you cannot lose on purpose then that activity is nothing but luck. You can purposely lose in chess, but you cannot purposely lose in betting.
Interesting find
That’s it!
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Enjoy your weekend!