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You're basically saying investing is random chance. Ok. What is the p-value that Warren Buffett's random investment plan outperforms the market 39/47 years? h

You're basically saying investing is random chance. Ok. What is the p-value that Warren Buffett's random investment plan outperforms the market 39/47 years? http://finance.fortune.cnn.com/2012/02/25/buffett-berkshire-hathaway-results/ http://finance.fortune.cnn.com/2012/02/25/buffett-berkshire-... If a drug beat a placebo in 39/47 experiments, would it be approved by the FDA? :-) There are investors who get lucky, and there are investors with sound strategies. The notion that every winning strategy gets immediately and flawlessly applied by every actor in the market is a fantasy world populated by homo economicus.

zeckalpha 13y ago
That's a fundamental misunderstanding of random. Investing being random chance doesn't mean everyone will do about average. It means that some people will make quite a bit of money and some people will lose quite a bit of money. It just happens that Warren Buffet is an outlier.
- throwawaymsft 13y ago
  I'm not sure I understand. Buffett has a strategy X, which has defeated strategy Y (buy a market index fund) 39/47 times. We can say any return in strategy X is 1) Due to random chance (i.e., it defeated the market 39 times "randomly") 2) Not due to random chance, and there is an inherent advantage I'm saying the probability of 1) is sufficiently low so as to believe 2).
  - Thrymr 13y ago
    The question is, how many potential Warren Buffets were there in the pool to start with? You can't ask the question "what are the chances that this particular outcome would happen?" with a sample of one, you have to use the population it is drawn from. Otherwise it would be like saying "That's amazing! The lottery numbers today were 56 23 45 12 27 91! What are the chances!" Exactly the same as any other combination (very, very low). The trick is picking them in advance.
  - lutusp 13y ago
    You're missing the point. What is the probability that someone flipping a fair coin will flip 20 heads in an unbroken sequence? The answer is 2^-20 = about 9.5 * 10^-7. Next question. How many people need to be flipping coins for one of them to have a better than even chance to flip 20 heads in a row? Answer: about 3/4 million. Next question. How many investors are there in the world? Answer: many more than 3/4 million. Next question. If someone among millions of investors makes 20 successful market picks in an unbroken sequence, what's the probability that he will attribute that outcome to blind chance, and what is the probability he will start selling a book titled "Secrets of the Winners" on late night TV? My point? When confronted by an unexplained occurrence, it's wise to consider the possibility that it's a random outcome. This is called the "null hypothesis" and it's the first possibility a scientist considers.
  - zeckalpha 13y ago
    While the probability of any individual defeating the market is 0.5 in any given year, the probability of someone from the pool of N investors getting beating the market 39/47 years is N * 0.5 ^ 47. (It's been a while since I've done probability, so correct me if I'm wrong.)
    - lutusp 13y ago
      > the probability of someone from the pool of N investors getting beating the market 39/47 years is N * 0.5 ^ 47. No, that's wrong. If the original performance had been an unbroken sequence of successful years, say, 39, it would be possible to apply the binomial theorem to it, but the binomial theorem would need to be applied both to the original probability and to the calculation of how many investors would be needed to create a better-than-even prospect of that outcome. But the 39 successful years were randomly distributed among years where the performance wasn't better than market indices, which makes the probability much higher for it being explainable by chance -- how much higher depends on the actual pattern, which I wasn't able to find.
    - magnusjonsson 13y ago
      (47 choose 39) * 0.5 ^ 39 * 0.5^8 = 0.0000022, so that'd be about 1 in 500000 of all who traded for this long.
lutusp 13y ago
> You're basically saying investing is random chance. No, what I am saying is that random choices can produce the illusion of successful investment strategies for 1/2 the practitioners. This isn't at all controversial -- it's equivalent to saying that half of people are above average in intelligence. > What is the p-value that Warren Buffett's random investment plan outperforms the market 39/47 years? That's not a particularly interesting question (and it's not an improbable unbroken streak of 39 years, but a mixture of successes and failures, much more likely to result from chance). What is more interesting is to ask what Buffett's market performance would have been without the announcement and herd effects? Everyone wants to invest in the same stocks Buffett invests in, and Buffet's investments are public knowledge. The herd can be relied on to make Buffett's choices after he has established his position, which means he's positioned to benefit from the public's responses to his choices. Again, I never claimed that investing is random choice. I only said that random choices work for 1/2 the investors, and those investors are likely to attribute their success to genius instead of chance.
- throwawaymsft 13y ago
  > That's not a particularly interesting question (and it's not an improbable unbroken streak of 39 years, but a mixture of successes and failures, much more likely to result from chance). Why is any particular permutation of 39 wins and 8 losses more improbable than another? That's like saying HHHTT is more likely than HTHTH. > The herd can be relied on to make Buffett's choices after he has established his position, which means he's positioned to benefit from the public's responses to his choices. But now you're playing it both ways. Are markets efficient or not? Can't every rational investor realize the herd will do this and just ape Buffett? I may have misunderstood, but your thesis seems to be that markets are efficient, and no strategy can consistently beat the market over time. My thesis is that we have an existence proof that isn't the case.
  - lutusp 13y ago
    >> That's not a particularly interesting question (and it's not an improbable unbroken streak of 39 years, but a mixture of successes and failures, much more likely to result from chance). > Why is any particular permutation of 39 wins and 8 losses more improbable than another? That's like saying HHHTT is more likely than HTHTH. Again, that is not what I said. Are you trying to misinterpret, or is this all inadvertent? Had I anticipated your effort to misinterpret, I would have said that a random sequence of 39 heads is less probable than three sequences of 13 heads, each separated by some other unidentified, random sequences or, as I put it originally, "a mixture of successes and failures". >> The herd can be relied on to make Buffett's choices after he has established his position, which means he's positioned to benefit from the public's responses to his choices. > But now you're playing it both ways. Nonsense. I'm explaining how any outcome can be attributed to chance, not that they are explained by chance. > Are markets efficient or not? That's not even a topic, and if it were, it wouldn't be a binary choice. > I may have misunderstood, You thoroughly misunderstood, no ambiguity. And no offense meant. > ... but your thesis seems to be that markets are efficient, and no strategy can consistently beat the market over time. No to the first (no one knows) but absolutely yes to the second -- no strategy can consistently beat the market over time. Isn't that obvious? Any strategy that consistently beat the market, and that could be expressed as a deterministic algorithm, and that was something other than a transient effect of no real value, could be used to drain the market of its capital in a matter of months -- and therefore it would be. The market would collapse and businesses would refuse to trust equities. My point? If there really was such a strategy, it would demolish the market, meaning there would be no remaining market to beat consistently. The golden goose would lie dead. Just think a bit more deeply.

zeckalpha 13y ago

That's a fundamental misunderstanding of random. Investing being random chance doesn't mean everyone will do about average. It means that some people will make quite a bit of money and some people will lose quite a bit of money. It just happens that Warren Buffet is an outlier.

throwawaymsft 13y ago
I'm not sure I understand. Buffett has a strategy X, which has defeated strategy Y (buy a market index fund) 39/47 times. We can say any return in strategy X is 1) Due to random chance (i.e., it defeated the market 39 times "randomly") 2) Not due to random chance, and there is an inherent advantage I'm saying the probability of 1) is sufficiently low so as to believe 2).
- Thrymr 13y ago
  The question is, how many potential Warren Buffets were there in the pool to start with? You can't ask the question "what are the chances that this particular outcome would happen?" with a sample of one, you have to use the population it is drawn from. Otherwise it would be like saying "That's amazing! The lottery numbers today were 56 23 45 12 27 91! What are the chances!" Exactly the same as any other combination (very, very low). The trick is picking them in advance.
- lutusp 13y ago
  You're missing the point. What is the probability that someone flipping a fair coin will flip 20 heads in an unbroken sequence? The answer is 2^-20 = about 9.5 * 10^-7. Next question. How many people need to be flipping coins for one of them to have a better than even chance to flip 20 heads in a row? Answer: about 3/4 million. Next question. How many investors are there in the world? Answer: many more than 3/4 million. Next question. If someone among millions of investors makes 20 successful market picks in an unbroken sequence, what's the probability that he will attribute that outcome to blind chance, and what is the probability he will start selling a book titled "Secrets of the Winners" on late night TV? My point? When confronted by an unexplained occurrence, it's wise to consider the possibility that it's a random outcome. This is called the "null hypothesis" and it's the first possibility a scientist considers.
- zeckalpha 13y ago
  While the probability of any individual defeating the market is 0.5 in any given year, the probability of someone from the pool of N investors getting beating the market 39/47 years is N * 0.5 ^ 47. (It's been a while since I've done probability, so correct me if I'm wrong.)
  - lutusp 13y ago
    > the probability of someone from the pool of N investors getting beating the market 39/47 years is N * 0.5 ^ 47. No, that's wrong. If the original performance had been an unbroken sequence of successful years, say, 39, it would be possible to apply the binomial theorem to it, but the binomial theorem would need to be applied both to the original probability and to the calculation of how many investors would be needed to create a better-than-even prospect of that outcome. But the 39 successful years were randomly distributed among years where the performance wasn't better than market indices, which makes the probability much higher for it being explainable by chance -- how much higher depends on the actual pattern, which I wasn't able to find.
  - magnusjonsson 13y ago
    (47 choose 39) * 0.5 ^ 39 * 0.5^8 = 0.0000022, so that'd be about 1 in 500000 of all who traded for this long.

lutusp 13y ago

> You're basically saying investing is random chance. No, what I am saying is that random choices can produce the illusion of successful investment strategies for 1/2 the practitioners. This isn't at all controversial -- it's equivalent to saying that half of people are above average in intelligence. > What is the p-value that Warren Buffett's random investment plan outperforms the market 39/47 years? That's not a particularly interesting question (and it's not an improbable unbroken streak of 39 years, but a mixture of successes and failures, much more likely to result from chance). What is more interesting is to ask what Buffett's market performance would have been without the announcement and herd effects? Everyone wants to invest in the same stocks Buffett invests in, and Buffet's investments are public knowledge. The herd can be relied on to make Buffett's choices after he has established his position, which means he's positioned to benefit from the public's responses to his choices. Again, I never claimed that investing is random choice. I only said that random choices work for 1/2 the investors, and those investors are likely to attribute their success to genius instead of chance.

throwawaymsft 13y ago
> That's not a particularly interesting question (and it's not an improbable unbroken streak of 39 years, but a mixture of successes and failures, much more likely to result from chance). Why is any particular permutation of 39 wins and 8 losses more improbable than another? That's like saying HHHTT is more likely than HTHTH. > The herd can be relied on to make Buffett's choices after he has established his position, which means he's positioned to benefit from the public's responses to his choices. But now you're playing it both ways. Are markets efficient or not? Can't every rational investor realize the herd will do this and just ape Buffett? I may have misunderstood, but your thesis seems to be that markets are efficient, and no strategy can consistently beat the market over time. My thesis is that we have an existence proof that isn't the case.
- lutusp 13y ago
  >> That's not a particularly interesting question (and it's not an improbable unbroken streak of 39 years, but a mixture of successes and failures, much more likely to result from chance). > Why is any particular permutation of 39 wins and 8 losses more improbable than another? That's like saying HHHTT is more likely than HTHTH. Again, that is not what I said. Are you trying to misinterpret, or is this all inadvertent? Had I anticipated your effort to misinterpret, I would have said that a random sequence of 39 heads is less probable than three sequences of 13 heads, each separated by some other unidentified, random sequences or, as I put it originally, "a mixture of successes and failures". >> The herd can be relied on to make Buffett's choices after he has established his position, which means he's positioned to benefit from the public's responses to his choices. > But now you're playing it both ways. Nonsense. I'm explaining how any outcome can be attributed to chance, not that they are explained by chance. > Are markets efficient or not? That's not even a topic, and if it were, it wouldn't be a binary choice. > I may have misunderstood, You thoroughly misunderstood, no ambiguity. And no offense meant. > ... but your thesis seems to be that markets are efficient, and no strategy can consistently beat the market over time. No to the first (no one knows) but absolutely yes to the second -- no strategy can consistently beat the market over time. Isn't that obvious? Any strategy that consistently beat the market, and that could be expressed as a deterministic algorithm, and that was something other than a transient effect of no real value, could be used to drain the market of its capital in a matter of months -- and therefore it would be. The market would collapse and businesses would refuse to trust equities. My point? If there really was such a strategy, it would demolish the market, meaning there would be no remaining market to beat consistently. The golden goose would lie dead. Just think a bit more deeply.