Invisible

Think about 2 persons getting arrested by police and kept in 2 separate cells.

Each is being given a choice to either remain silent or blame the other person.

Here are the scenarios:

  • If both remain silent, the sentence is 1 year
  • If one remains silent and the other blames him, the accuser goes free while the one remaining silent gets sentenced to 5 years
  • If both blame each other, both get 3 years in jail

What’s the most rational thing to do?

Obviously, act in self-interest.

However, acting in self-interest still gets you 3 years in jail, while remaining silent gets you free in 1 year.

Again, you don’t know what the other person is going to do so the rational choice will be to blame the other person and hope for the best.

That ladies and gentlemen is the prisoner’s dilemma when presented with choices whose outcome can depend upon how others will react.

Think of Elections

In any election where there are more than 2 choices, it is very difficult to get a free, fair and rational choice that is elected by actual majority.

In effect, the candidate with highest votes might have been rejected by the majority but gets the highest number of votes and hence gets elected.

This is Arrow’s impossibility theorem refers to.

The Invisible Hand

The laissez faire theory propounded by Adam Smith proposed that everyone acting in their self-interest shall create the maximum social benefit.

Because as you start thinking of cooperation, it can soon become collusion benefiting a few.

Countries have made elaborate rules to tackle collusion.

As collusion benefits only a few.

Who does it hit?

The individual small guy.

Mafia

“Oh, private equity is a mafia”.

That’s what an investor told me a few days back.

The best of the deals only goes to the same people and all we are served is sloppy seconds.

That’s what regulated markets try to prevent but can they.

Individuals think they can beat the market by doing research, uncovering hidden gems, and accumulating positions before the big fish.

However, the markets are unique in the way that big fish create liquidity.

They move the tide and the broaden the interest in prices to go up.

So, you need the big guys, however the big guys will enter before you and would have cornered the fat gains so you might be the one holding the can at the end of the run or you might get in early and wait forever because the big guys don’t get in at all.

What to do?

No one can make anyone believe that they can’t achieve something.

In fact, the mere suggestion becomes an ego battle.

So, what’s the way to think about it as an individual investor:

  • Segregate your portfolio
  • Have 1 part in quality or index funds
  • Have a small part to play the ego game and make yourself believe that you are a great investor

Remember, investing and driving is same.

In driving an accident will not only hurt the other person but also you plus the repair expenses.

Similarly, ego investing decision might help your ego but not your wealth.

Acting in your self-interest will mean balancing your ego with your need to grow your wealth.

Ultimately, you don’t have anything to prove anyone through your personal portfolio.

Remember that.

Thanks for Reading

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