The Puzzle that Puzzled the Most Brilliant Minds...and its Implications for Investors - The 5 Minute WrapUp by Equitymaster
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The Puzzle that Puzzled the Most Brilliant Minds...and its Implications for Investors

Jul 1, 2017
In this issue:
» GST's Impact on Household Expenses
» Weekly Market Round Up
» ....and more
00:00
Rahul Shah, Co-Head of Research

Imagine you are in the hot seat of an exciting game show...

Before you are three doors.

Behind one of the doors is a shiny new car...and behind the other two are goats.

The rules are simple. You choose a door. And if that door opens to reveal the car, you win. The car is all yours. However, if the door opens to reveal a goat, you lose. You walk away empty handed. You don't even get the goat.

Now it gets interesting...

Suppose you choose a door. And once you do, the host of the show also chooses a door, which always opens to reveal a goat. Always.

Now, given the chance to change your mind, would you like choose the third door instead or would stick to your original choice? In other words, is it to your advantage to change your mind?

It shouldn't make much of a difference, right? The car could be behind either of the two doors. You have a 50:50 chance either way, right?

Wrong...

Turns out, changing your mind is the better option. By switching, you improve your odds of winning the car to 67%.

Wait... Huh?

This puzzle has tripped even the smartest of guys. Reportedly, approximately 10,000 readers, including nearly 1,000 with PhDs, wrote to the magazine that published this puzzle claiming they'd lost it.

But switching is indeed the better option.

In the beginning, when you choose a door, your odds of winning are one out of three. However, the new information changes the scenario.

Once the second door with the goat opens, new information emerges that improves your odds to two out of three...if you switch. But if you don't switch, your odds remain one out of three.

Still not buying it?

It may take a while to sink in. It just doesn't seem consistent with the way we think. But this is how the world operates. These are the laws of mathematics and psychology at work. And we'd better get used to it if we want to crack such puzzles...or investment success, for that matter.

We have all invested in a stock only to not act as new information emerged.

The information could be anything from the stock price going up to the company's margins taking a hit...to news of a stretched balance sheet or an ambitious acquisition.

I am not saying we must calculate odds as every bit of new information emerges. That's not possible. But it is certainly not a bad idea to keep an eye out on the ever-changing business landscape and be open to changing direction if the situation calls for it.

We never know which door the car is behind. But we can improve our odds of avoiding the goats.

Unfortunately, we are usually fine holding onto stocks even as new information indicates they may turn out to be goats.

PS: My colleagues Kunal and Rohan have hit upon a brilliant way to avoid doors with goats behind them. How? First, they only consider stocks in which super investors have taken a stake. Then, from this ultra-select universe, they run their own filters to find the crème de la crème...de la crème!

The popular trial offer for their new recommendation service, Smart Money Secrets, ended yesterday. But my publisher has extended the offer through the weekend for 5 Minute WrapUp readers ONLY. Take advantage of this new information: Try Smart Money Secrets today and improve your odds of investment success just as more than 4,000 other smart readers have done.

02:30 Chart of the Day

Finally, India's biggest tax reform - Goods and service Tax (GST) is a reality. Yes, after a lot of speculation around the timely implementation, GST has been rolled out.

As we have saying, GST is a much-needed economic reform. It should eventually expand India's narrow tax base and increase government revenues.

That said, every coin has two sides. GST is no exception. It will have its fair share of chaos in the coming months. There could be protests across the country over tax rates and compliance burdens and it could affect the smooth functioning of the economy.

While GST will impact businesses and industries in a big way, it won't directly affect the salaried class and self-employed personnel (Aam Aadmi). Since it is an indirect tax, it does not change the way they pay their personal taxes. The only impact they will see would be due to the change in rates of the goods and services they avail.

GST's Impact on Aam Aadmi's Spending

03:30

Mario Draghi, president of the European Central Bank hinted at a change in the direction of monetary policy. This set a sell-off in most major global markets in anticipation of increase in interest rates. A sharp increase in crude oil prices also spooked financial markets.

The decline in oil prices over the last three years has been one of the major drivers of global stock markets. Higher crude oil prices mean higher inflation for the US economy which approached 3% during the first part of 2017. US markets ended lower by 0.6% this week.

Meanwhile, Brazilian markets rose higher this week as shares of state-controlled oil company PetrÓleo Brasileiro SA rose higher along with crude oil prices. Brazilian markets have been volatile lately owing to uncertainty related to the country's political crisis. Brazilian president Michel Temer was under a political storm after bribery allegations surfaced against him earlier this year. The Brazilian market closed the week up by 2.3%.

Back home, Indian share markets concluded a historic week with the nationwide launch of GST at the stroke of midnight today. Implementation of GST promises to transform India into a single common market and there are many sectors which will gain immensely from this transition. The implementation of the same is bound to bring more companies under the new tax regime, thus providing a level playing field to organized players that face huge competition from the unorganized segment. Although markets are bound to be turbulent due to short term uncertainty across sectors as the GST is implemented. The Indian stock market ended the week lower by 0.7%.

Performance During the Week Ended 30th June, 2017

04:50 Weekend Investment Mantra

"Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we're trying to do. It's imperfect, but that's what it's all about." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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2 Responses to "The Puzzle that Puzzled the Most Brilliant Minds...and its Implications for Investors"

Sudhir Mahale

Jul 4, 2017

Very interesting. Took lot of time to sink in. The take for me from this example is, I should watch my investment very closely every day and decide on actions based on any change in situations. Thank you,

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Krishna Kumar

Jul 3, 2017

What you said about the puzzle is true. Before boarding the aircraft, I asked what is the probability of a person carrying a bomb in this flight. The person at the counter said one in a million. And I asked "what is the probability of two person carrying a bomb?" One in 10 million he said. So I pleaded to allow me to carry a bomb, so that odds would change from one in a million to one in 10 million. But for some reasons he didn't agree. Now I understand why.

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