Are you an investing sharpshooter šŸ”«

 

Sometimes I believe in as many as six impossible things before breakfast.

: Lewis Carroll, Alice in Wonderland.

Ā 

 

In Texas a shooter goes to the side of a barnĀ and fires 20 shots. He then finds 5 hits that are next to each other and draws a bull eye around it and claims to be a sharpshooter. This joke is the basis of what is called the “Texas sharpshooter fallacy”.

 

The assertion of sharpshooting cannot be replicated but the evidence is there for all to see. And the evidence blinds us to ask the most important question – future replicability.

 

Similar sharpshooting happens in investing all the time. Here are some example you may come across:

1. Showing and talking about winning trades on social media to get people to sign up for expensive investing courses or option seminars.

2. Promoting thematic baskets that have done well recently as evidence of skill to charge high fees.

3. Bragging about multi-bagger stocks in parties for social gratification (w/o disclosing portfolio allocationĀ or stockĀ portfolio returns).

 

 

Carl Sagan, the famous astronomer and planetary scientist,Ā onceĀ said “Extraordinary claims require extraordinary evidence“. He was only paraphrasing French mathematician Laplace who framed the principle some two centuries prior as “the weight of evidence for an extraordinary claim must be proportioned to its strangeness.” – strangeness being how infrequently the claimĀ is observed.

 

Now think about a thematic basket that shows evidence of ~5% outperformance to Nifty 50 in aĀ 3 years backtest and implicitly through clever wordings promises something similarĀ for the next 15 years šŸ™‚

 

How strange or extraordinary is this claim? Or to put it differently, in all theĀ fund manager / investor return data we have, how many times do we see such extraordinary returns sustained over 15 year periods?

 

In 40 years of market dataĀ the odds that your thematic basket managerĀ would string a 15 year track record of extraordinary performance like above is ~ 1 in 32,000. (Ps: some basketsĀ claim 10-15% annual outperformanceĀ šŸ¤Æ. The odds there would be a magnitude lower still.)

 

That is 0.003%.

 

ThisĀ is your odds of findingĀ such a thematic basket managerĀ as well. The evidence of a 3 year backtest (not real performance and not including costs) is paltry faced with such extraordinary claims. Same holdsĀ for the option seminar peddler showing 10% monthly returns. Cropped screenshots (probably doctored) of random days showing big returns just does not cut it as evidence of such an extraordinary claim. It is negligibleĀ evidence built on super shaky grounds andĀ no rational person shouldĀ fall for this. But many do, because of two reasons. One, they don’t realise how extraordinary the claim is and two, their brain goes into “greed” mode and rationality takes a backseat.

 

As an investor be careful on which investment sharpshooter puts a nice bulls eye around your hard earned wealth.

 

 

Happy investing,
Gaurav
CEO | kuvera.in
@rustapharian

 

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2 Responses

  • Kunchala Ajay

    November 15, 2021 AT 15:19

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