Are you an investing sharpshooter ?

Gaurav Rastogi

3 years ago

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

: Lewis Carroll, Alice in Wonderland.

In Texas a shooter goes to the side of a barn 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 allocation or stock portfolio returns).

Carl Sagan, the famous astronomer and planetary scientist, once 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 claim is observed.

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

How strange or extraordinary is this claim? Or to put it differently, in all the 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 data the odds that your thematic basket manager would string a 15 year track record of extraordinary performance like above is ~ 1 in 32,000. (Ps: some baskets claim 10-15% annual outperformance ?. The odds there would be a magnitude lower still.)

That is 0.003%.

This is your odds of finding such a thematic basket manager as well. The evidence of a 3 year backtest (not real performance and not including costs) is paltry faced with such extraordinary claims. Same holds 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 negligible evidence built on super shaky grounds and no rational person should 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.