Survival of the Smartest

asx 300 stocks financial education investment teaching techniques money managers stock market risk wealth Aug 03, 2024

Many well known authors and advertising gurus talk about the need to have a good story if you want people to buy your product or take away a specific point from your lesson.

The belief is an appeal to the emotions will make it easier for people to remember your main point.

Humans love storytelling.

It is both a way to be social and connect with others and provide some sense and continuity to an event.

On the flip side, maths and probabilities don’t really make for good stories. For most of us, there isn’t any emotions in 1+1=2 (or algebra for that matter).

But they do make for good investing.

And I always want to highlight the simple maths that can help you understand how simple investing really is and therefore improve your chances of success.

For me personally, maths has much more influence on me than stories. It is probably why I prefer value to growth - growth always has a story whereas value, for me, just slaps you in the face.

So it’s numbers over narratives.

So here I want to tell a story but the main point is the maths.

Let’s take Bill and Ted. Both start with $100,000. Bill takes a more aggressive strategy and generates growth of 10% but has a failure rate of 5%. Ted is more conservative and generates growth of 8% but his failure rate is lower at 1%.

Here’s the weird part - Bill will be wealthier than Ted, but Ted will end up richer.

If you only think about one year, Bill will be richer 95% of the time (5% failure rate leaves 95% success). So Bill ends up with 95% times $100,000 times 10%. Or $104,500.

Ted, using the same formula ends with $106,920.

Why?

The key is survival. And a concept called survivorship bias. Because Ted fails less than Bill, his probability of surviving is higher since his failure rate is only 1%.

This is why it is important to understand risk, the probability of a loss and the impact it can have on your final wealth. Many great investors and gamblers will tell you the first rule is survival. No matter how good the opportunity, never go the Full Monty. This little story helps you remember to always make sure you have a portfolio that can survive a serious downturn even when looking a higher potential returns.

It's the losses that matter.

So be careful when the financial industry encourages you to “go for growth”, ignoring the higher risk of losing.

This is why investing when markets are overvalued is dangerous. Because no matter how much you have made, it is about the current risk. Yes, compounding is important, but as you can see, it is avoiding losses that makes you richer in the long run.

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