Many people would choose the peanut butter option. After all, it’s only a 5% chance…
We often incorrectly treat a low-probability event as impossible, but when there are many trials (and in this case we will assume that you have a long life ahead of you), you can rationally expect the negative outcome tooccur as often as the probability says it will. In this case, 5% of the time. So, for the next 365 days, you would expect about 18 peanut butter-filled days. That’s nearly two days per month. Over the next 50 years, you could reasonably expect over 900 days of peanut butter coverage—that’s a lot of PB!
There are two important takeaways for investors:
- The improbable tends to happen far more frequently than most anticipate, or most importantly, plan for. Economies go through recessions, bubbles burst, companies go bankrupt, people lose their jobs, and oil prices crater. Therefore, we must make investing decisions that can provide resilience to such inconceivable events.
- It is critical to understand the cost of the improbable event. In our example, unless you are allergic to peanuts, the cost is relatively low. But compare this to a scenario in which the costs are extremely high. For example, imagine that instead of waking up with a 5% chance of being covered in peanut butter, there was a 5% change of complete financial ruin. Put this way, many people would easily forego their favourite pizza.
Although scenarios like this are great for debate, the underlying math is not. An outcome with a low probability—if independent and there are many trials—is by definition still expected to occur at some point.
Improbable events will occur eventually, and we can’t always predict when they will happen. At Mawer we believe that by following a time-tested, systematic, and disciplined investment approach, we can help put the odds in our clients’ favour over the long term—no matter how many peanut butter days turn up.