We all know that monkeys (or darts) can pick stocks just as well as most fund managers. Why? The amrkets are very close to being efficient. Thus any fund manager, in theory, has no advantage over any other unless he knows something the markets don't (and most of the time they do).
But we do know that certain managers seem to consistently pick good stocks... so do they know something everyone else doesn't? Probably not. In a pool of 1,000 fund managers we would expect that a handful will have a great record, and a handful will have a terrible record... but most will be average... even if they all pick their stock portfolio's at random.
The human mind, being a great pattern recognizer, has a terribly difficult time accepting the fact that good performance over an extended time period (for a complex prediction problem like the stock markets) may just be a product of randomness.
And thus here is a wonderful method for fooling some people most of the time - the example is for convincing people to purchase your pick for this year's super bowl winner:
- Start off with a list of 132,000 people for each football team.
- Week 1 of NFL football, send out predictions for each team to the corresponding list. For each team make 50% of the predictions on the list wins, and the other 50% losses.
- Week 2 of NFL, for those on the list who had a correct prediction, repeat step 2.
- Week 3 - 16, repeat step 3 taking the previous week's winners and assigning a random prediction.
- By week 16 (the super bowl), there will be 16 teams playing and for each team you'll be left with about 1 person for whom your prediction has been correct every single week.
- Offer each of the 16 people the chance to buy your predictions for the playoff at 100 dollars the first round, 500 dollars the second round, $1,000 dollars for the Championship, and $5,000 for the super bowl.
- Assign a win prediction to each person left, as their team cruises towards the Super Bowl the will more and more excitedly hand you their money (and gamble off their life savings).
- After the Super Bowl offer the winner the chance to purchase next seasons predictions for the low price of $1k, but only if he signs up each of his friends for $1k each.
- Take your $40k (assuming you get your Super Bowl winner and 10 of his friends to purchase for next year), and head to Mexico... try not to get Bernie Madoffed.
In the world of stocks the above example is equivalent to having a 20 year track record of excellent returns!
Now you tell me... how much of your hard earned money do you want to invest in my mutual fund? Really... with a track record like ours... how much could you possibly lose?