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Latticework of Mental Models: Risk Aversion Vs Loss Aversion

On April 10, 2003, Pepsi announced a contest called “The Pepsi Billion Dollar Sweepstakes”. It was scheduled to run for 5 months starting from May in the same year.

For the contest, Pepsi printed one billion special codes which could be redeemed either on their website or via postal mail. According to Pepsi’s estimate, about 200-300 million of these codes were redeemed. Out of these, 100 codes were chosen in a random draw to appear in a two-hour live gameshow-style television special. Each of these 100 people were assigned a random 6-digit number, and a chimpanzee (to ensure a truly random number and of course to rule out any monkey business) backstage rolled dice to determine the grand prize number. This number was kept secret and the 10 players whose numbers were closest to it were chosen for the final elimination. On the evening of September 14, the final day of the contest, the event, titled Play for a Billion, was aired live. If a player’s number matched the grand prize number, he would win US$ 1 billion.
(Source: Wikipedia)

Given the scenario, it was highly unlikely that anyone would win a billion dollar. The chances were literally 1 in a billion. In spite of that, Pepsi was unwilling to bear the risk of the possible billion-dollar prize. So they arranged for an insurance company to insure the event. They paid US$ 10 million to Berkshire Hathaway to assume the risk. Yes, Warren Buffett’s Berkshire Hathaway. The same guy who is famous for his two iron rules –

1. Never lose money
2. Don’t forget rule number 1.

Then why would Buffett expose his company to such a big risk for a relatively paltry premium of US$ 10 million? Isn’t this akin to playing Russian roulette?

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How to Generate Stock Ideas: An Unusual Lesson from a 1939 Book

One of the best books I read before starting on my journey of building Safal Niveshak was James Webb Young’s A Technique for Producing Ideas, originally published in 1939. After all, I was trying to build my idea bank for things I wanted to do in life then.

In this book, Young lays out with brilliant simplicity the five essential steps for a productive creative process. Explaining how the production of ideas is largely a result of process than talent, he writes –

The production of ideas is just as definite a process as the production of Fords; that the production of ideas, too, runs on an assembly line; that in this production the mind follows an operative technique which can be learned and controlled; and that its effective use is just as much a matter of practice in the technique as is the effective use of any tool.

My limited experience in investing suggests that what is most valuable to know about idea generation is not just where to look for a particular idea, but how to train the brain in the method by which all ideas are produced and how to grasp the principles which are at the source of all ideas.

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Being Lucky Vs Being Good

Let’s say you sponsor a contest to determine the “world’s best coin flippers.” About 100,000 people from across the world come together to participate in this contest. Everyone flips a coin at the same time.

After each coin flip, those who flip “tails” must leave, until the only people left have flipped 10 consecutive heads. Basic statistics suggests that we could expect about 98 coin flippers to remain at the end of the contest.

The odds of flipping heads 10 times in a row are 1/2^10 = 1/1024. So, for 100,000 participants, there will be 100,000/1,024 = 98 people who would have flipped 10 consecutive heads.

Then, these 98 “skilled” coin flippers would get thousands of likes on Facebook, and followers on Twitter. Those with the best smile and social media skills will write bestselling books about coin flipping, sharing their secrets of how to become a world-class coin flipper.

Anyways, let’s now consider investing. If just 50% investors outperform the stock market every year, the odds of one investor outperforming every year for 10 years would be 1/1024. That is, just one out of 1,024 investors would achieve this feat of outperforming the market every year for 10 years.

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Safal Niveshak Stream – Three Magic Words for Investing Your Money

Some nice stuff I am reading, watching, and observing at the start of this weekend…

Beware of Charismatic CEOs

Guy Spier’s The Education Of A Value Investor is a book that reads like having a friendly conversation with a wise friend. It’s one of those very few books where the authenticity is reflected on each page and you can tell that every word has come out straight from the heart.

One of the most important things required for long term investing success, as I have learnt so far, is following a sound investment process. According to Guy, a sound process is a robust set of rules that makes our investment decisions smarter and less vulnerable to the distortions of our irrational brains.

Guy has developed eight such rules to bring an analytical rigour to his process. Here is one rule which made a lot of sense to me and cleared my dilemma about the need to talk to the management. He writes –

…my own experience is that close contact with management is is more likely to be detrimental to my investment returns. The trouble is, senior managers—particularly CEOs—tend to be highly skilled salespeople. No matter how their business is performing, they have a gift for making the listener feel optimistic about the company’s prospects…But this gift of the gab doesn’t necessarily make them a dependable source of information…This isn’t to say that CEOs, CFOs, and other top executives are malicious or immoral…They may be skewing information subconsciously, without any bad intent. But it doesn’t matter. Knowing my own rational limitations, I’d prefer not to expose myself to this potentially distorting influence.

If I want to assess the quality of the management, I’d rather do it in a detached and impersonal way by studying the annual reports and other public data, along with news stories.

So the rule is: Beware of CEOs and other top management, no matter how charismatic, persuasive, and amiable they seem.

And of course there are always some exceptions to every rule. Spier writes –

Exceptions to the rule: Berkshire’s chairman and CEO, Warren E. Buffett, and a small but growing minority of CEOs (at companies like Fairfax Financial, Leucadia National Corporation, and Markel Insurance) who take seriously the idea of sharing what they would like to know if they were in their shareholders’ shoes.

Meeting with management can seriously distort your view and mess up with your mind. Do that only if you’re confident about your ability to keep your mind insulated from a host of biases (Liking, Authority etc.) coming from the charismatic personality of the CEO.

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One Powerful Success Secret from Ben Franklin that Changed My Life

When I tell people how I manage my entire business on my own – from website management, to reading, writing, sending mailers, to organizing workshops and also booking a lot of travel tickets – a lot of them are in disbelief.

They disbelieve me even more when I tell them that I work for just 5-6 hours a day and take a lot of family holidays.

Well, I do not have any Masters degree in time management, but one thing that has really helped me manage my time well is a simple secret I’ve learned from people like Ben Franklin and Warren Buffett.

That simple secret is that of…

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