Sunday, November 30, 2008

Post 470 : The fallacy of performance...

An epiphany recent struck me on the topic of "investment performance".....

Invariably, we calculate performance on two basic params:
1. Against a benchmark.
2. Against what we started off with.

I will ignore the first, but look at the 2nd point closely.

Lets for sake of making this easy, assume I had Rs.100 as my corpus on 30th Nov 2007. Lets say tomorrow this has fallen to Rs. 40. My performance for the past year - reduction in corpus to the extent of 60%.

Now assume, on 30th Nov 2009 I am back at Rs.100. My performance is a 250% gain.

Summary :
Rs. 100 on 30th Nov 2007
Rs. 60 on 30th Nov 2008
Negative returns of 60%
Rs. 100 on 30th Nov 2009
Gains of 250% for the year.

Notice the skew....get the drift.

Upside is always from a position lower and hence looks very sexy, downside is always from the "stated top" and hence looks like a soft landing.

None of what I said above is illegal or unethical. Its just that the way we calculate, seems to impact human pysche such that we always underestimate a fall and we always are delighted with a rise.

Whats the point?...Nothing, really, just helps to know how we are hardwired.

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