Lake Woebegone part I

Lake Woebegone refers of course to Garrison Keillor's fictional location in Minnesota. Keillor has been in the news lately, apparently recovering from a stroke and providing a reasonable opportunity to highlight the Lake Woebegone Effect (henceforth "LWE"). In fictional Lake Woebegone, "all the women are strong, all the men are good-looking, and all the children are above average."

Obviously, it is impossible for everyone in a population to be "above average" as it violates the laws of math, logic and common sense. Before the statistic minded among you yell "it IS possible, it's called asymmetry"-  we aren't referring to this effect. As usual, Wikepedia (Karl's favorite) does a good job explaining the LWE:

"the human tendency to overestimate one's achievements and capabilities in relation to others (in academic sources this is more usually called the above average effect or the better than average effect)"

We find this human tendency nearly everywhere we look. For example, I fancy myself a better than average writer. Judge for yourselves, but I am probably not. Anyway, what brings me to this topic today is a press release I received this morning. It highlights the opinions of a large group of investment advisors and their predictions for the economy, market and interest rates.

The press release is written in such a way as to imply that the collective wisdom of this group is somehow superior to other groups or individuals. But isn't this group of experts only a subset of the larger group of financial experts? The only thing making this particular collection or subset a "group" is by the arbitrary fact they all have a relationship with a certain organization. The grouping is not because the members were invited based on their track records or elected "superior" by some larger body, although the press release would like the reader to believe this group is better. And no track record supports the notion the group is in fact better at predicting the future. Once again, we find the message "our group is better than average, so choose our group."

I find this particularly amusing when it refers to Wall Street. Despite its name, Wall Street is really collectively the hundreds of thousands of investors, traders and bankers around the world who affect the capital markets. Though we often like to call many of them idiots, technically they are anything but idiots. The Street knows it has two forms of capital: dollars and intellectual. The dollars aren't like rabbits multiplying on their own and so The Street has learned that to make lots of money, it needs to employ smart people. Hundreds of thousands of very smart people, all looking at the same data, same quotes, the same opportunities and trading the same securities. Collectively, they are "the market" more or less. In fact, a money manager must walk into the office every day thinking they are smarter than the rest of The Street and therefore capable of outperforming it. A massive ego and self confidence (over confidence?) is required. The reality is that any arbitrarily selected subgroup sample (i.e. mostly randomly selected) is going to perform in line with the average of the population it is selected from. To think anyone with a Wall Street pedigree is better than the rest of Wall Street by virtue of their Wall Street pedigree is a mistake.

*Note: I called this "Lake Woebegone part I" because I have no doubt this topic will crop up again. It segues nicely into several behavioral biases such as self attribution bias, hindsight bias, illusions of knowledge and control amongst others).