February 15, 2011
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It's a truth that's tough to accept, but by the Asian parenting standards set forth by Amy Chua of Tiger Mom fame, my mother, though Asian, was a complete failure.
She never made me take piano lessons.
She never knew from one day to the next whether I did my homework or not.
She waited until the day I received my high school diploma, when I was up to my ears in flower leis, to ask why my grade point average wasn't high enough for me to graduate with honors. (Jeez, I thought, I got into Princeton for pete's sake. What are you hassling me for?)
So when I met Kaiser Fung at a Princeton alumni event - he with the degrees from Princeton, Harvard and Cambridge - I was willing to bet his mother was a much better Asian parent than mine. You don't rack up fancy-pants degrees at that clip by going on too many sleepovers.
In addition to being great company, Kaiser is a statistician extraordinaire. His book Numbers Rule Your World (Soundbite: it's the Freakonomics of statistics) is so interesting and so fun to read that we sent it to all our clients as a New Year's present. When he inscribed my copy with the words "Don't be average!", I was hooked. That, after all, is my battle cry.
And while one of us is undereducated and the other is not, we both equally despise that single-point estimate otherwise known as an average. "Averages are like sleeping pills," says Kaiser. "They put you in a state of stupor, and if you overdose, they may kill you."
In our business, there are a couple of ways we get averages wrong, both of which have to do with a failure to "unpack" the numbers. The first has to do with the components of average returns; the second relates to extrapolating trends from averages (and compounding them into idiocy).
Average returns need to be unpacked
Consider the compound average growth rate of a business or a portfolio. Kaiser said he's been struck by the number of business people who have trouble wrapping their heads around the dangers inherent in keying into an average return that does not take variability into account.
As he points out, "While the compound annual growth rate provides a useful basic summary of the past, it conveys a false sense of stability when used to estimate the future."
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