If the last 5 coin flips were:
What’s the probability on the next coin flip?
– DSP Mutual Fund (@dspmf) June 13, 2020
It is a fascinating question and of-course the obvious rational answer is that if the coin is NOT Rigged (Like in the movie Sholay), every new coin flip would have the same 50% probability of coming as Tails or heads. Past performance has absolutely no bearing on probability of what happens next.
What is the practical utility of this information. The message of this breaking the bias is that in situations, where the variables are defined, you should be going with the probability of an event and not get swayed by recency of results.
Read the above statement AGAIN, The utility of this bias busting comes with a condition. The condition is that the variables should be defined. In other words, situation should be bookish and NOT REAL LIFE.
Real life is NOT a coin toss. Real life has variables well and beyond the limited maths of this flip of a coin. Lets take an example. Lets just say you were lucky enough to catch Warren Buffet in his infancy of his professional money manager career and a friend of yours told you of this Omaha dude who has been averaging 120% CAGR from last 05 years. Your decision to NOT park your funds with him and discard him as a coin toss anomaly would haunt you for the rest of your life.
Or an individual stock example, lets just say you were able to SPOT DMART as an Awesome buy right at the time of its IPO. But you discarded the opportunity based on horrible IPO odds that your favorite value investor tweeted about with a hashtag IPO = It’s Probably Overpriced
The obvious rebuttal to this survivor ship bias based selection that I did above is that for EVERY 01 Warren Buffet, there are a million loser fund managers and for every one DMART, there are a 1000 dud IPOs.
And I agree, but we need to take this argument to its logical conclusion. You cannot have it BOTH WAYS, u see. Based on the argument above, it MAKES absolutely ZERO sense to invest in ACTIVE EQUITY FUNDS. because there out-performance (if at all) is a coin toss anomaly and they are bound to REVERT to the mean, which is mediocre.
And hence my conclusion is that if you believe in the coin toss example as a rational way of thinking, you are essentially promoting EMH (Efficient market hypothesis) or INDEX Investing .
It makes No sense to pay additional expenses (index funds are way cheaper than active) FOR A COIN TOSS LUCK.
Comments are welcome………………