Wealth Depends on Magnitude, Not Frequency

Becoming wealthy does not depend on how many times your judgment is right. It depends on whether you dare to bet when right and can cut losses when wrong. Wealth depends on the magnitude of individual outcomes, not their frequency. There is a term, “Simpson’s paradox,” proposed by British statistician E. H. Simpson in 1951. It means that you can win more within individual groups yet, when everything is added together, lose overall. Stanley Druckenmiller, Soros’s colleague, once said: “I learned a lot from Soros, but perhaps most importantly, it is not whether you are right or wrong, but how much you make when right and how much you lose when wrong.” Soros’s strategy is to strike at the critical point with decisive force. The great investment fortunes of this era have largely followed this pattern. Buffett wrote in his 2010 shareholder letter: “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” Soros and Buffett are predators that wait for the right moment, strike, and do not let go. Two insights underlie this approach. First, truly great wealth opportunities arise only a few times in a lifetime. Buffett says every investor should imagine having a decision card with only twenty punches. Each investment uses one, until the card is full. This reminds us not to make decisions too frequently. Second, small successes do not mean much. Buffett’s partner Charlie Munger said: “Remove our ten most successful investments, and we would be a joke.” Many investors trade frequently, making small gains and hoping they accumulate. Yet overall profits remain modest, and a market decline wipes them out. Both insights reflect a broad rule of modern society: concentration at the top, or the power law. The strong get stronger, and leaders keep widening their lead. Business thinkers have repeatedly highlighted this trend in recent years. In his bestseller Zero to One, Peter Thiel argues that the world is disproportionate and follows the 80/20 rule. Invest only in the best, because the best create more value. Investors find that their largest winner returns more than all their other investments combined; the second-largest returns more than all those below it. Thiel gives an example. In 2010, the US venture firm Andreessen Horowitz invested $250,000 in Instagram. Two years later, Facebook bought the company for $1 billion. Andreessen made $78 million—a 312-fold return in less than two years, already a miracle. But its fund was $1.5 billion. If one investment produces only $78 million, it would need nineteen such miracles just to break even. That is extraordinarily difficult. Understanding this explains why investors put more money into companies worth backing. China offers many examples too. After founding Hillhouse Capital, Zhang Lei invested most of the $30 million raised from Yale’s investment fund in Tencent—a concentrated bet. He then invested in JD.com. Founder Liu Qiangdong initially wanted only $70 million. Zhang said: “If you only want $70 million, I won’t invest. If I invest, it will be $300 million.” After JD.com went public, Hillhouse held 11.31%, making it the fourth-largest shareholder and earning a substantial profit. You might ask: isn’t this simply telling us to gamble heavily? The risk is enormous. Indeed, most of us struggle to summon such courage. It goes against common sense and intuition. Former MIT professor Dan Ariely writes in Predictably Irrational that, when facing multiple choices, people resist abandoning alternatives even when they know one offers the greatest success. Our brains instinctively resist risk. Few achieve enormous wealth because few overcome that psychological instinct. You may then ask how to recognize the crucial opportunity and bet everything on it. I do not know. I even suspect nobody knows. Lao Yu makes a witty observation in that article: truth often has two characteristics. First, it is simple. Second, it has no operating manual. Today we have discussed only a phenomenon. Nobody can tell us the operating instructions for exploiting it. Tomorrow we will discuss another part of the article. There is something else whose rule is precisely the opposite: magnitude does not matter; frequency does. That is our sense of happiness.