Investing Under Uncertainty: The Charitable Lottery
A lesson in how to build a long-term investment strategy.
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In investing, quality of process matters more than quality of outcome.
That is not to say that quality of outcome doesn’t matter—it does—but if you want to build a long-term edge you need to continuously make favorable bets as part of your investing strategy.
Favorable bets don’t always turn out as expected, but that doesn’t make them mistakes.
The Charitable Lottery
To explain this idea, let me introduce you to The Charitable Lottery.
The rules of The Charitable Lottery are simple. You bet a 100 dollars and with a 90% chance you get back 1000 dollars. Talk about being charitable, eh?
You’re a bit hesitant. It sounds too good to be true, doesn’t it? You hesitate, but your friend goes ahead, places his bets, and wins 3 times in a row. As your friend greedily counts his three thousand dollars, you decide it’s your turn.
You place your bet aaaaand… you lost.
Did You Make A Mistake?
So much for being charitable, huh?
It might be easy to conclude that you made a mistake participating in the lottery. After all, you’re short a 100 dollars. However, the expected value of the bet is 900 dollars for a 100 dollar buy-in! Incredible odds!
You made the right decision despite the adverse outcome.
Implications for Investors
As investors, it is our job to make favorable bets. However, even if we correctly identify such bets, we will occasionally suffer losses simply due to chance.
Just like in The Charitable Lottery.
When evaluating past investment decisions—whether they went better or worse than expected—we should always focus on whether we overlooked something that we could have known at the time of the decision.
And that’s how we grow as investors.
Thanks for Reading
Hope you enjoyed this piece.