BBRG: Shark Attacks Illustrate an Investing Problem

Shark Attacks Illustrate an Investing Problem
Single or rare events should never be used to draw conclusions about, well, anything.
Bloomberg, January 28, 2019

 

 

One of the key lessons of behavioral economics is the danger of not examining your own beliefs. Failing to consider the reasons that underlie our decision-making increases the risk of error. Although we can operate in our daily life on autopilot, other situations are not so forgiving. When we put capital at risk, the danger of not understanding what influences our decisions can be monetary losses, career risk or worse.

In this context, let’s consider the aphorism, “the plural of anecdote is not data.” This is the idea that a single example should never be used to extrapolate a broader rule about, well, anything. This applies to stocks, the economy, politics, Brexit — just about any situation where a compelling narrative might influence your views in spite of a dearth of evidence.

The truth of this statement is so self-evident that there seems to be little reason to have to investigate whether the quote is accurate or not. We tend to use it almost reflexively, usually in an attempt to refute a conclusion that cites a data point. Anecdotal evidence is not mathematically or scientifically sound. When our sample set consists of a single example (N = 1), our conclusion will have a margin of error of plus or minus 100 percent. In other words, as the fine print states, it is statistically insignificant.

 

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I originally published this at Bloomberg, January 28, 2019. All of my Bloomberg columns can be found here and here

 

 

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