I’ve been reading a bunch about Ergodicity.

Here’s why it’s important in your life.

Traditional economic theory has real problems because generally economists have always assumed that the expected outcome for an event is equivalent to the average of all outcomes.

But at the individual level, all that matters is the path through time (a point thoroughly ignored by economists). People care what happens to them, not what happens to the group on average.

Let me illustrate what I mean: if you had a million people playing a game over an hour, where you start with $100, and every minute you toss a coin, if it’s heads you multiply your wealth by 150% and if it’s tails you multiply by 60%. So after one run, you could either be at $150 or $60. That in itself looks like a favorable game, you make more than you lose on any toss.

This game has positive expected value = 50% x $150 + 50% x $60 = $105

Now the results for any one person will be noisy, but if you do this for an hour (60 tosses) over a large population, the average wealth of the million people looks like this:

That looks like a great game and the positive expected value is adding up. It looks like a game that will on average make you rich.

Would you play this game ?

Remember what you and I care about isn’t the result for the overall population, but what happens to us.

So in the earlier example, we had got rid of some of the noise in the system by averaging the results across a million people over an hour, the other way we can reduce the noise is by observing just one person but over a long period of time.

So if you played this game every minute for a year, your wealth would look like this.

A very different result indeed !

What is happening is that the group average (ensemble) over emphasizes exceptional success (luck) over a short period of time, while the time perspective reflects what really happens to the average individual playing this game.

An ergodic system is one where the ensemble perspective and time perspective will have the same outcome. These systems are pretty common in the physical world, and it makes sampling useful in those systems.

But finance and business are non-ergodic.

The way Naval Ravikant (I’m a fan) has summarized the idea of non-ergodicity is:

“Six people playing Russian Roulette once each is not the same as one person playing it six times.”

Nassim Taleb summarized this idea well in his essay: The Logic of Risk Taking (recommended reading). I’ll borrow a picture:

The big idea here is path dependency matters to individuals.

Why do people playing a favorable game (positive expected value) go broke in the long run ?

Answer: They bet 100% of their money in the game every time. And all it takes a long streak of tails - each of which would have costed them 40% of their money - to eventually take them out of the game. 

Which leads to the question in games (markets) where path dependency matters, would you play a game in which there was a 50/50 chance of being wiped out even if it was positive expected value. What about a 20%, 10% or 1% probability of being wiped out.

Investing and running businesses is non-ergodic - ensemble and time perspective are not the same. Survival is key.

If you lose all your money, or a large part of your money, there is no coming back anymore. And the one thing that takes people out of the game or substantially out of the is a large position size in a just a few bets gone wrong.

Which reminds me of a Peter Bernstein quote:

“The riskiest moment is when you’re right. That’s when you’re in the most trouble, because you tend to overstay the good decisions. Once you’ve been right for long enough, you don’t even consider reducing your winning positions. They feel so good.”

What have you been most right about ? What feels so good that you can’t bear reducing your position ?

B. I was reading this fun article on 52 things I learned in 2019, which had some crazy facts:

1. Black women in the United States die in childbirth at roughly the same rate as women in Mongolia.

2. Each year humanity produces 1,000 times more transistors than grains of rice and wheat combined. 

3. Worldwide, growth in the fragrance industry is lagging behind cosmetics and skincare products. Why? ‘You can’t smell a selfie’.

And it made me reflect on the year and think about what I had learned this year. I am still reflecting on 2019, but for 2018 some of big lessons that I learned about myself were:

1. Seek people smarter than you, but find time to help good people too

2. Sometimes you just have to say NO !

3. Set goals and relentlessly focus on making them a reality

What about you ? What did you learn this year ?

A Few Things Worth Checking Out:

1. ‘My reading strategy is to start as many books as I can but finish few of them. Years ago I heard Charlie Munger say “Most books I don’t read past the first chapter. I’m not burdened by bad books,” and it stuck with me. Reading is a chore if you insist on finishing every book you begin, because the majority of books are either a) adequately summarized in the introduction, b) not for you, or c) not for anyone. Grinding your way to the last page of these books – a habit likely formed early in school – can turn reading into the equivalent of a 10-hour work meeting where nothing gets done and everyone is bored’…….Great article on How to Read.

2. Sometimes in finance and investing, we think working harder and doing more complex things, makes it more likely that we will make money….but that’s usually not true. Effort does not equal to alpha like most other areas of human endeavor.

3. American Affairs article arguing that the real class war isn’t between the 99% and 1%, but between the 10% and the 1%….

4. Shopify is now a $40bn company, having tripled this year, but I bet most of you haven’t heard of it.

Tobi Lutke is the founder and CEO of Shopify. In this great interview he discusses how they are taking on Amazon by empowering anyone who wants to sell online, how to build companies, the future of retail and the importance of neural diversity in your business.

5. Josh Wolfe and Peter Thiel on a panel at the 2019 Reagan National Defense Forum discussing How Venture Capital Impacts Defense.

6. I’m a little light on reading books these days, because I’ve been using the commute to learn two new languages - Mandarin on the way in and French on the way out. I’m using Memrise and Duolingo. It’s amazing what you can do in an hour every day.

Quotes I’ve been thinking about:

Husband and wife co-authors, Rosamund and Benjamin Zander, on optimism:

"People who describe the glass as half full are not delusional optimists. In fact, they are more based in reality because they are describing a substance that is actually in the glass. They are describing reality as it is. The cynic who describes the glass as half empty is focusing their energy on something that is not actually there."

- The Art of Possibility by Rosamund Zander and Benjamin Zander

"to have a great career, go do impressive things, then tell people about it."

"If you want to do a good deed, do it now. The time will pass, and you will not have the chance again."

"I've always liked Hamming's famous double-barrelled question: what are the most important problems in your field, and why aren't you working on one of them? It's a great way to shake yourself up. But it may be overfitting a bit. It might be at least as useful to ask yourself: if you could take a year off to work on something that probably wouldn't be important but would be really interesting, what would it be?"

- Paul Graham

“The dynamic of friendship is almost always underestimated as a constant force in human life: a diminishing circle of friends is the first terrible diagnostic of a life in deep trouble: of overwork, of too much emphasis on a professional identity, of forgetting who will be there when our armored personalities run into the inevitable natural disasters and vulnerabilities found in even the most average existence.

[...]

But no matter the medicinal virtues of being a true friend or sustaining a long close relationship with another, the ultimate touchstone of friendship is not improvement, neither of the other nor of the self; the ultimate touchstone is witness, the privilege of having been seen by someone and the equal privilege of being granted the sight of the essence of another, to have walked with them and to have believed in them, and sometimes just to have accompanied them for however brief a span, on a journey impossible to accomplish alone.”

- David Whyte

Thanks for your continued friendship this year and beyond.