In 40 years of market data the odds that your thematic basket manager would string a 15 year track record of extraordinary performance (i.e market beating) is ~ 1 in 32,000. that is 0.003%.
The takeaway was that the 0.003% odds are so minuscule that you might as well invest in a low cost index instead of chasing hot new managers with hot new themes.
Not everyone bought it. But what about Warren Buffet, Peter Lynch and so many other famous investors with unbelievable investments streaks they said. How could the odds be so low? They have to be higher, much higher. Part of it is because people want the odds to be higher for themselves, they want to achieve these outstanding investment returns.
Let’s look at the lottery to see what we can learn about this situation above. Let’s say 10,000 people each buy one lottery ticket including you. It is straightforward that your odds of winning the lottery is 1 / 10,000. That is 0.01% The lottery will eventually have a winner, so the odds that someone will win the lottery is 100%. We just don’t know who that person is. But because such people exist, they have to as someone will win the lottery, would you think your odds of winning the lottery goes up?
It’s pretty much the same concept with investing.
Let’s go back to my example with 40 years of market data and 8,000 thematic basket managers. Just like the lottery, the odds that after 40 years we will have one manager that had a 15 year investing streak is 3/4 i.e 75%. Yup, that high!
Of course, just as in a lottery we will have no way of knowing who the manager is and when the streak will start. But rest assured someone will win the investing jackpot too.
The basic confusion here is that the probability that an event will happen leads us to overestimate the probability that the event will happen to us. The visible winners make the event more likely especially when the losers are hidden and out of sight. In lotteries, it is public knowledge about how many people played the lottery and who won, so calculating probabilities is easier. In investing no one talks about losing portfolios making it seem like investing is easy and the probability of stupendous investing gains is something that can easily happen to us.
There are many investing lessons hidden in lotteries, but the most important one is encapsulated beautifully in this joke.
Every night, a man prays to God, “Please god, let me win the lottery tomorrow”. Years go by and the man continues to pray. Finally, one night he says, “I am asking you for the last time God, let me win the lottery tomorrow”. And God replies, “Okay son, but help me this time and buy a freaking ticket!”.