Michael Mauboussin gave his name to a simple idea: it's not how many times you're wrong that counts, but how big your successes are. Babe Ruth, a famous baseball player with the Boston Red Sox and, more importantly, the New York Yankees after his transfer in 1919, is known for his many home runs. Although he often missed, his successes were spectacular and left their mark on the history of his sport.
In the investment world, we often hear phrases like "if I'm good 51% of the time, I'll make it". But it's not that simple. One famous investor told the story of being part of a group of portfolio managers. The company treasurer, dissatisfied with overall performance, decided to evaluate each manager. He thought that even a random selection would result in a portfolio where half the stocks outperformed the market. But this manager showed that even if most of his stocks lost a little, a few that rose a lot were enough to make his portfolio a success.
"The frequency of correction doesn't matter, it's the size of the correction that counts."
This is particularly true in long-term investing and private equity, where most performances are driven by a few big champions and offset the losses of other losing positions.
Peter Thiel explains that returns are often highly skewed. The best investors understand that a few investments can yield huge returns, even if many fail. Around 6% of investments generate 60% of total returns. Good venture capital funds hit hard, but also often miss. It's like baseball: you can't hit big hits without missing. People are naturally afraid of losses.
Behavioral economists like Daniel Kahneman have shown that losses affect us more than gains. This leads investors to sell their winning stocks too soon and hold on to their losers for too long. But to be successful, you have to think in terms of expected value, not just frequency of success.
The Babe Ruth effect teaches us that in investing, as in other probabilistic fields, what counts is the magnitude of successes, not their frequency. It's a counter-intuitive but essential lesson for those who want to excel in the world of finance.
