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Poke the Box: Make a Ruckus, Take Risks…but Remember Base Rates

Let’s Start with Safal Niveshak
Just in case you missed any of this on Safal Niveshak over the last few days…

  • Released StockTalk 2.0 report on India’s leading IT services company, TCS. See some interesting discussion in the Comments section of the report.
  • Safal Niveshak turned two on 11th July, so relived the amazing journey so far. I want to thank you, dear tribesman, for raising this initiative to this point — it truly could not have happened without your support!
Mental Model of the Week: Base Rates

I heard this recently in a radio ad of a leading insurance company – “For every minute you are stuck in the traffic, we settle five claims.”

Sounds great, right? Five claims in one minute is quite a number.

“But, five out of how many claims that you receive, sir?” I wanted to ask. When I got back home and checked the claim-settlement number, it was around 70%! Now that’s poor!

“There is nothing more deceptive than an obvious fact,” said Sherlock Holmes.

Then, Bertrand Russell said, “Obviousness is always the enemy to correctness.”

It happens so often in life that we come out with wrong conclusions because they seem the obvious based on a single observed effect.

When someone remarked to the French writer Voltaire, “Life is hard,” he retorted, “Compared to what?”

We tend to ignore alternatives, and therefore we fail to make appropriate comparisons. Often we only consider information or evidence that is presented or available and don’t consider that information may be missing.

In effect, we ignore the base rates, which simply mean that if 1% of the public were “medical professionals”, and 99% of the public were not “medical professionals”, then the base rate of medical professionals is simply 1%.

In the same way, if 2% of penny stocks earn good long-term return, and 98% don’t, then the base rate of success in penny stock investing is just 2%.


Here is what Prof. Sanjay Bakshi said in his interview with Safal Niveshak…



One of the great lessons from studying history is to do with “base rates”. “Base rate” is a technical term of describing odds in terms of prior probabilities. The base rate of having a drunken-driving accident is higher than those of having accidents in a sober state.

So, what’s the base rate of investing in IPOs? When you buy a stock in an IPO, and if you flip it, you make money if it’s a hot IPO. If it’s not a hot IPO, you lose money.

But what’s the base rate – the averaged out experience – the prior probability of the activity of subscribing for IPOs – in the long run?

If you do that calculation, you’ll find that the base rate of IPO investing (in fact, it’s not even investing…it’s speculating) sucks!

That’s the case, not just in India, but in every market, in different time periods.

What you don’t see can really kill you! And people don’t see the base rates.

——-

When you evaluate whether smoking is good for you or not, if you look at the average experience of 1,000 smokers and compare them with a 1,000 non-smokers, you’ll see what happens.

People don’t do that. They get influenced by individual stories like a smoker who lived till he was 95. Such a smoker will force many people to ignore base rates, and to focus on his story, to fool themselves into believing that smoking can’t be all that bad for them.

What is the base rate of investing in leveraged companies in bull markets?



By the way, here are some base rates of dying for different reasons (as per the US National Center for Health Statistics)…

  • Hand gliding – 1 in 560
  • Grand Prix racing – 1 in 100
  • Motorbike racing – 1 in 1,000
  • Mountain climbing – 1 in 1,750
  • Bicycling – 1 in 140,000
  • Running/Swimming– 1 in 1 Million (1 Million = 10 Lac)
  • Car driving – 16 in 100,000 drivers
  • Motorcycle riding – 21.5 in 100 million vehicle miles
  • Airplane – 1.3 deaths in 100,000 flight hours
  • Smokers – 22x more likely to die of lung cancer than non-smokers
  • Lifelong smokers – 50% die before age 70
  • Dance parties – 1 in 100,000

Finally, regardless of all risks, your probability of dying during a given year doubles every 8 years!

So watch out for base rates before making any decision in life (and investing), and please be careful.

Stimulate Your Mind
Here’s some amazing content I read during the week gone by…

Poke of the Week – Take Risks

The leading American entrepreneur, author and public speaker Seth Godin has had a great influence on my life as a writer and thinker.

In his recent book titled The Icarus Deception, Seth writes about the story of Icarus, whose father Daedalus fashioned two pairs of wings out of wax and feathers for himself and his son to fly out of a prison they were captivated in.

Daedalus tried his wings first, but before taking off from the island, warned his son not to fly too close to the sun, nor too close to the sea, but to follow his path of flight. However, overcome by the giddiness that flying lent him, Icarus soared through the sky curiously, but in the process he came too close to the sun, which melted the wax.

Icarus kept flapping his wings but soon realized that he had no feathers left and that he was only flapping his bare arms, and so he fell into the sea.

The Icarus myth is often used as an example of when hubris or over-confidence – of flying too high – can go badly wrong.

However Seth, in his book, points out that there is another part of the story – Icarus’s father Daedalus also told his son not to fly too low as the water could also damage his wings.

As per Seth – “Society has altered the myth, encouraging us to forget the part about the sea, and created a culture where we constantly remind one another about the dangers of standing up, standing out, and making a ruckus.”

However, he writes, settling for too little is “a far more common failing”.

You see, we all have the potential to do great work in life. However to do so, we need to leave our comfort zones – to fly closer to the sun, and to fail sometimes.

If you’re not failing every now and again, it’s a sign you’re not doing anything very innovative.

Looking from another angle, if you’re hitting bull’s-eye every time, maybe you’re standing too close to the target.

Like when it comes to investing, I have a long list of great stocks that I did not buy or sold early, for a simple reason that I feared taking some risk.

But since these errors of omission won’t show up in my profit and loss account, I often ignore them.

The reality is that our errors of omission – not flying high and close to the sun – can be more costly than the errors of commission – flying too close to the waters.

Thankfully, what I omitted – taking risks – in my investing life, I committed in my work life, and that led me to quit my job to pursue my passion.

Ask yourself what stops you from taking risks in your life – not risks based on arrogance and blind overconfidence, but well-calculated risks like…

  • Building up a saleable skill that people would pay for, and then telling your boss that you won’t need his services soon
  • Telling your boss how his excel-based projections could go haywire
  • Starting a business that you have been wanting for years
  • Researching businesses and then investing in them independently
  • Spending time learning a third, or a fourth language
  • Learning how to swim or drive…or cook

Arthur Koestler put it so well – “If the Creator had a purpose in equipping us with a neck, he certainly would have meant for us to stick it out.”


Just answer this question – “What would our world look like if more people moved out of their comfort zones, made a ruckus, and took risks to change their and others’ lives?”

Maybe this could be your permission slip.

If you haven’t done it already, sign up here to receive Poke the Box in your email…and get ready for stimulating Saturday mornings.

Keep poking.

Make a ruckus.

Take risks.

Remember base rates.

Please try to quit smoking.

Till next weekend…

Vishal Khandelwal
Chief Poker – Poke the Box

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Akhilesh Pathak says:

    Dear Vishal,

    Loved the ” Base Rate” Model.. Need to calculate the base rates for ” Multibaggers” to show why we should not run behind them 🙂

    Devdutt Pattanaik has different take on power and corruption.

    Couldn’t agree more with Seth Godin on taking risks and creating a ruckus. Similar thoughts from Karl Albrecht ( He is a German entrepreneur who founded the discount supermarket chain Aldi. Albrecht is the richest person in Germany – net worth of $25.4 billion as of 2012).

    “The typical human life seems to be quite unplanned, undirected, unlived, and unsavored. Only those who consciously think about the adventure of living as a matter of making choices among options, which they have found for themselves, ever establish real self-control and live their lives fully. Everything you do (or choose not to do) is a choice. Most of us think that life happens to us, but in reality life is something that we choose either by actively pursuing options and creating our own circumstances, or by blocking opportunities and limiting our beliefs of what is possible. You can choose the type of life you want to live.”

    Warm regards
    Akhilesh

  2. Maheswar says:

    Thanks for another good post Vishal.

    Liked the sketch showing the two circles of comfort zone and where magic happens. As the saying goes “A picture is worth a thousand words”. Will pin this sketch up on the wall around the house to serve as a reminder to get out of the comfort zone more frequently.

    Have a good day.

  3. Deepen V says:

    Liked all your Poke the Box Issues..!
    Can certainly gauge your thinking process by the Articles and interpretations that you choose.
    Keep up the good posts..

  4. Many Thanks Vishal ji for posting such a wonderful article.
    I liked the Base rate article in particular.

    Regards.

  5. thanks a ton…the sketch showing the two circles of comfort zone and where magic happens was too gud..already taken the print & put it on my desk!
    thanks.

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  1. […] the past…and so I don’t avoid companies with high debt to equity. I don’t understand the base rate of success of companies that have high […]

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