Well, if we look at all the billions of people on this planet [AJC: is it 6 billion or 8 billion now … damn, I lost count] … the chances are minuscule.
If we take all the people who use the Internet daily … still microscopic.
If we take all the people who read Personal Finance blog … not much chance.
If we pick all people who read the self-prophesying headline to this post …. bloody great! You see, it WAS a trick question of sorts …
… all to lead me on to the subject of Probability … as in “it’s probable that your eyes will glaze over just about now, and you’ll click back to Pamela Anderson’s home page” … brought to my attention by a recent post from an excellent blog by All Financial Matters, appropriately titled Probability 101.
Even if you hated math [AJC: in other countries, known as: maths] and statistics, stick with me past this excerpt:
I’m in the process of reading Peter Bevelin’s awesome book, Seeking Wisdom – From Darwin to Munger (Not an Affiliate Link). I HIGHLY recommend this book for anyone interested in investing and behavioral finance. As boring as that sounds, this book is a page-turner. One of the sections of the book that I found most interesting was this illustration of probability on page 151:
A lottery has 100 tickets. Each ticket costs $10. The cash prize is $500. Is it worthwhile for Mary to buy a lottery ticket?
The expected value of this game is the probability of winning (1 in 100) multiplied with the prize ($500) less the probability of losing (99 our of 100) multiplied with the cost of playing ($10). For each outcome we take the probability and multiply the consequence (a reward or a cost) and then add the figures. This means that Mary’s expected value of buying a lottery ticket is a loss of about $5 (0.01 × $500 – 0.99 × $10).
The first comment that I would make is that whilst you need to understand the basics of a ‘good decision’ against a ‘bad decision’ in probability/statistical terms, simply running your eye over the key line “A lottery has 100 tickets. Each ticket costs $10. The cash prize is $500” should do the trick:
If you bought all 100 tickets, at $10 each, you would spend $1,000. But you would only win the cash prize of $500 … are YOU smarter than a 3rd Grader?
But, as one of the comments on that post pointed, out not all decision that SEEM to be mathematical ARE simply mathematical:
Unfortunately, probability doesn’t always translate directly into real-life situations.
Let’s take your example of the lottery, except we’ll change things up a little.
Mary is 50 years old and approaching retirement. She’s been financially savvy for her entire life and has accumulated $1M in cash.
Donald Trump decides to hold a lottery for only Mary. One ticket costs $1M, and she has a 50% chance of winning $10M.
If you looked at just probability, her EV is -(0.5 x $1M) + (0.5 X $10M), or +$4.5M. Does that mean she should buy the ticket? Obviously, no.
I think what this comment is saying is that EVEN THOUGH you have a 50/50 chance of winning 10 times your money, you shouldn’t invest your entire life savings into it … because you have an equal chance of ending up flat broke!
The concept is good, but I take issue with the “obviously no” bit …
The numbers in this example are ridiculously skewed for most people, so I tried to give some ‘closer to home’ examples in my post centred on that popular game show, Deal or No Deal.
It all boils down to this:
When a decision is potentially Life Changing … the numbers count less … the possible result counts more.
1. You should understand basic probability because it is so important in life,
2. You should first make the Life Decision then look at the odds …
Deal or No Deal?!