Updated: Mar 10, 2021
How often have you heard someone complain that they made a boneheaded mistake and let a Nio (NIO), or an eXp World Holdings (EXPI), or a Plug Power (PLUG) pass them by, losing out on 1,000% growth in a year? How often have you felt that yourself, as you watch a could-have-been-yours stock heat up?
The bad news is that, in investing, there’s no avoiding these mistakes.
The good news is, they’re not actually mistakes. A missed opportunity or a bad call on when to buy or sell is most often not the result of an error in judgment, but chance.
Consider this scenario: you and a friend make a bet on the outcome of a common six-sided die. One of you will put up $75 and, if the die lands on a 1, 2, 3, 4, or a 5 will win $100. The other party will put up $25 and if the die lands on a 6 will win the pot. Which side should you take?
Obviously you take the ‘safer’ bet: you have a five-in-six chance of winning a small sum (a 33% gain), while the other side has only a one-in-six chance to quadruple it.
The die rolls and… comes up on a 6. You’re out $75, and your friend has quadrupled their ante.
That doesn’t mean you made the wrong choice! If you were to repeat this game a hundred times you’d almost certainly come up the overall winner. This event was an outlier – but that doesn’t take away the sting of losing $75.
What I want to point out is that taking the safer choice in this scenario was an error, but not an error in judgment. It’s not a mistake to trust the numbers*. The real mistake is to pursue a bad bet because you’ve got FOMO (Fear of Missing Out) or because it worked out for you once.
Sometimes you’ll make a choice that doesn’t work out. Sometimes your financial advisor will! Sometimes the markets are irrational. Trust the numbers, and don’t let your investing become gambling.
If you have questions or want to speak with someone about refining your investing strategy, reach out and talk to us.
*In this scenario, unlike the stock market, we have really easy numbers to work with. Let me show you how the thinking goes:
If you have a five-in-six chance to win a bet, you’re looking at an 83% chance in your favor. If you’ve got a one-in-six chance, you’re looking at about 17%. If we apply those percentages directly to the potential winnings - $100, in this case – we can see what your expected winnings on the bet are: $83.33, or $16.67, in the two cases.
What that means for us is that in the first bet we’re making the smart choice by betting anything up to $82, more or less, to potentially win that $83.33. In the other case we’d be lacking sense if we bet anything more than $16 to win. That’s why I say that the $75 bet is a good one, and the $25 is a poor choice: they’re lower and higher, respectively, than what you’d expect to win on an 'average' throw.
In one bet – just one roll of the die – you won’t win $83 or $17, you’re either going to win all $100 or nothing. However, when we’re talking about whether we’re making a good bet on a game like this – or in the stock market – we have to imagine that we’re actually making hundreds or thousands of bets over time. Eventually, if you played enough times, your winnings would average out to those described above.