Page 186 - Morgan Housel - The Psychology of Money_ Timeless Lessons on Wealth, Greed, and Happiness-Harriman House Limited (2020)

Consider that 85% of active mutual funds underperformed their benchmark

over the 10 years ending 2018.⁶⁵ That figure has been fairly stable for
COBACOBA
generations. You would think an industry with such poor performance
would be a niche service and have a hard time staying in business. But

there’s almost five trillion dollars invested in these funds.⁶⁶ Give someone
the chance of investing alongside “the next Warren Buffett” and they’ll

believe with such faith that millions of people will put their life savings
behind it.

Or take Bernie Madoff. In hindsight his Ponzi scheme should have been
obvious. He reported returns that never varied, they were audited by a
relatively unknown accounting firm, and he refused to release much
information on how the returns were achieved. Yet Madoff raised billions of
dollars from some of the most sophisticated investors in the world. He told
a good story, and people wanted to believe it.

This is a big part of why room for error, flexibility, and financial

independence—important themes discussed in previous chapters—are
indispensable.

The bigger the gap between what you want to be true and what you need to
be true to have an acceptable outcome, the more you are protecting yourself
from falling victim to an appealing financial fiction.

When thinking about room for error in a forecast it is tempting to think that
potential outcomes range from you being just right enough to you being

very, very right. But the biggest risk is that you want something to be true
so badly that the range of your forecast isn’t even in the same ballpark as
reality.

In its last 2007 meeting the Federal Reserve predicted what economic
growth would be in 2008 and 2009.⁶⁷ Already weary of a weakening

economy, it was not optimistic. It predicted a range of potential growth—
1.6% growth on the low end, 2.8% on the high end. That was its margin of
safety, its room for error. In reality the economy contracted by more than
2%, meaning the Fed’s low-end estimate was off by almost threefold.