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>> Wednesday, June 23, 2010

In the book "The Black Swan" by Nassim Nicholas Taleb shared about misleading perceptions.

He mentioned about the turkey problem. The turkey is fed every day, and each day it grows to expect food, lowering its guard against unforeseen risk. Suddenly, on thanksgiving, the same hand that feeds it abruptly ends everything for the turkey.

An another example he used is the treatment of cancer. The doctor does the diagnosis and concludes that there is no evidence of cancer. There is no way to check every single cell, so the test is done by sampling. However, all it takes is a single cancerous cell to be undetected for it to start spreading. A stronger conclusion would be to state that there is evidence of no cancer.

Statistics can be such a misleading tool. Not seeing a person commit murder for 99% of his life does not mean we can conclude that he is innocent. However, seeing him commit murder is definite evidence that his is guilty.

Applying the concept to protection planning, many often perceive that nothing had happened to them, therefore nothing should happen in the future. It is similar to saying, since one has lived a 100 years, he will carry on to live another 100 more.

The same can be said about market cycles, it is often a build up of confidence during a bull run and markets make new highs, greed overtakes fundamentals. Suddenly, a crisis occurs and fear takes over, sending everything spiraling downwards out of control within a short period of time.

Hence, it is important to not fool ourselves that risk does not exist. We may not be able to prevent all of them, but we can try to identify them and take the necessary precautions to minimize the consequences.


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