Max, min and average payoffs

From Vernon, Chapter 7:

"He drew a distinction between activities with ‘positive scoring’, where success is defined by gaining wins, and activities with ’negative scoring’, where success is defined by avoiding faults.

Positively scored activities include selling, leadership, and most sports. In these activities bravery, ‘having a go’ and risk-taking give a better chance of success than careful deliberation, and the downside of making errors is low. Negatively scored activities include driving a car, piloting an aircraft, and anaesthetics in medicine. The successful driver, pilot or anaesthetist is not the brave one who always ‘has a go’, but rather one who never makes any big mistakes."

Here's a more succinct, more mathematical way of putting this.  For any activity, what's your payoff function - the max, the min or the average?

Max payoffs (Vernon's "positively scored" activities) Your payoff is your highest result.  Failure has no lasting consequences.   High energy, irrational optimism and persistence are optimal traits.  Don't worry about failure, just get on and "have a go."

Examples: selling, most sports, writing books(!).

Min payoffs (Vernon's "negatively scored" activities) Your payoff is your lowest result. A single failure may have lasting consequences.  Meticulous care, good judgment and respecting your limitations are optimal traits. Don't "have a go" unless you're sure you know what you're doing.

Examples: flying a plane, driving a car, anaesthetics.

(Weighted) average payoffs These are somewhere in-between.

Investment is an activity with weighted average payoffs.  But it helps - both because of the maths of compound growth (see earlier posts) and for psychological reasons - to place particular weight on the min payoffs. A lot of success in investing comes from just avoiding mistakes.

Another metaphor for this idea is winner's games and losers' games.  Tennis played between expert professionals is a winner's game: the winner is the player who hits the most winning shots.  Tennis played between mediocre amateurs is a loser's game: the winner is the player who makes the fewest unforced errors. In this sense, investment is probably a loser's game.

Guy Thomas Friday 25 February 2011 at 4:28 pm | | Default

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