Fooled by Randomness

Fooled by Randomness

Once upon a time there were two investors, the Lucky Idiot and the Skilled Investor. They were both hired on the same day by a mutual fund company. They were given $100,000 each to invest in the stock market for their clients.

The Lucky Idiot put all his money in an IPO called Vandalay Industries because his middle name was Vandalay. The stock immediately took off and made him a lot of money. By the end of the year his account was up 70 percent and he was hailed by his clients and his boss as a hero. The Skilled Investor after investigating some companies, took his money and invested it in about 9 different stocks in various industries while putting $15,000 aside for future opportunities. It was a difficult time in the markets that year with a recession going on and credit was tight. His return for the year was 5 percent. Decent considering the environment he was investing in but badly trailing the Lucky Idiot's performance. The boss called him in to his office and almost fired him, threatening him with dismissal unless he improved his performance the following year. The Lucky Idiot was given the keys to the executive washroom.

Now step into a time machine, just like the one Rod Taylor used in that 1960 movie, “The Time Machine”. Go forward in time 5 years and check out how our two investors are doing. The Lucky Idiot blew up in his second year and lost all the money in his account and was fired. The Skilled Investor continued his process of managing risk in his portfolio and at the end of 5 years he was up on average about 9 percent per year.

The Lucky Idiot is vowing to make a comeback by saving his money from washing dishes and return to the investing world. The Skilled Investor just finished his dinner and will be leaving his plate for the Idiot to wash.

Morale of the story...

Never judge someone's performance in the short run. Be sure to respect the law of large numbers. If you can outperform in the long run you have something going for you. And learn to manage your risk. That is your first job as an investor. Poor Lucky Idiot, he was fooled by randomness.

This little parable was based on the book...

Fooled by Randomness by Nassim Nicholas Taleb