Power of multiplied by zero

Multiplicative systems :Power of Multiply by zero - Mental Model series - 15

“Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without [integrity], you really want them to be dumb and lazy.” - Warren Buffet

Photo by Miguel Á. Padriñán from Pexels
Chain is a very good example of multiplicative systems. Let us start with the famous adage 'A chain is no stronger than it's weakest link' . when one link breaks , the entire chain breaks. Taleb calls  multiplicative systems as Fragile systems. Our human body is a fragile system but it has anti-fragile qualities. To learn more , read his book Anti-fragile. Multiplicative systems are governed by the weakest links or break points.

On the other hand we have additive systems . A wire rope is a good example. As you know, even when some of the wire break, it will hold. The outcome of additive systems is the sum of its parts, and the parts is independent. The outcome will not be win or lose , a binary.Instead if you change some parts , remove some parts and add some now and the outcome will be different ( becomes better or worse).  

We see this play out in many ways in life . Some of our life processes are additive systems and some are multiplicative.  Let us take your career for example. You seems to think you have ticked all the boxes: great resume, great background, great experience… but the problem is that you  suck at dealing with other people and treat others like stepping stones. That’s a zero that can negate all of the big numbers preceding it.  Get it?? 

Let us take another example from the book "Why nations fail" by Daron Acemoglu and James A. Robinson

In this book , Authors examine the factors could be responsible for determining countries success and failure.They argue the factors such as geographic, climate, culture, religion, political leader are either insufficient or defective in explaining it.

According to them, economic prosperity depends above all is whether the economic and political system is inclusive or extractive one.

Inclusive system, is a additive one, there is a lot of path to prosper, and you can compete freely.

and Extractive system, is an multiplicative one. there is few path to prosper, once you are there you need to keep other from stealing your position.

So understanding whether you are in an additive system or multiplicative system , then which components need absolute reliability for the system to work, is a critical model to have in your mind.

Footnote -
What are Mental Models ?
“It’s your mind’s toolbox for making decisions. The more tools you have, the more equipped you are to make good decisions. “
A mental model is an explanation of how something works. It is a concept, framework, or worldview that you carry around in your mind to help you interpret the world and understand the relationship between things. Mental models are deeply held beliefs about how the world works. 
For More , read Mental Models - Introduction

Compounding

Compounding - Mental model series - 14 

"Play iterated games. All the returns in life, whether in wealth, relationships, or knowledge, come from compound interest. "-Naval Ravikant

"Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. "— Albert Einstein

Compounding is when your interest earns interest.
It is a mathematical representation of positive feedback. 
It is the growth on your previous growth. 

Compounding plays out over the long term. In the short term, the incremental gains can be hard to notice.Also compounding applies to so much more than just your investments and credit cards.

Imagine a small, 3 inch snowball rolling across the snow. The small snowball picks up snow slowly (interest) with each roll. The snowball grows to 2x, 3x, 4x… The newly collected snow (interest) allows the snowball to pick up even more snow as it moves across the snow.

Now, imagine this snowball is your knowledge of a particular subject or your relationship with a close friend or your blog’s audience. Make small investments in these areas and watch your growth compound.

Consider James Altucher's 1 percent rule -

Improve a little each day. It compounds. When 1% compounds every day, it doubles every 72 days, not every 100   days. Compounding tiny excellence is what creates big excellence.

Charlie Munger  has spoken about this effect many a times -

  “I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.” - Charlie Munger USC Law Commencement Speech, May 2007

But a word of caution - one must be very careful on what are you compounding on ,
If you focus on wrong thing , compounding can be very expensive.
Then how to apply this mental model ?
Answer : Your compound base - Identify carefully

• What do you want to compound?

Jeff Bezo,Amazon CEO, Hintst on how to do compounding correct: focus on what will not change.

"I very frequently get the question: ‘What’s going to change in the next 10 years?’ And that is a very interesting question; it’s a very common one. I almost never get the question: ‘What’s not going to change in the next 10 years?’ And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time. … [I]n our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, ‘Jeff I love Amazon; I just wish the prices were a little higher,’ [or] ‘I love Amazon; I just wish you’d deliver a little more slowly.’ Impossible. And so the effort we put into those things, spinning those things up, we know the energy we put into it today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it. - Jeff Bezo

• Is it compoundable?- Make sure this is something compoundable and useful in the long run.
• Make sure your it has solid base - Don't bet on sand castles.For example -Expiring information is not knowledge. It won’t be relevant in a month or a year.Focus on accumulating knowledge that will be as useful ten years from now as it is today.Remember First principles ?

• How does it compound ? by time or in turn?      Business compounds when a transaction happens, and your bank account only compounds with time.

Ok, Let us conclude with some words of wizardry ,

Warren Buffet explains why stock market out performs bonds by attributing to compound interest -

"It was that simple. It wasn’t even news. People certainly knew that companies were not paying out 100% of their earnings. But investors hadn’t thought through the implications of the point. Here, though, was this guy Smith saying, “Why do stocks typically outperform bonds? A major reason is that businesses retain earnings, with these going on to generate still more earnings–and dividends, too.”


Footnote -
What are Mental Models ?
“It’s your mind’s toolbox for making decisions. The more tools you have, the more equipped you are to make good decisions. “
A mental model is an explanation of how something works. It is a concept, framework, or worldview that you carry around in your mind to help you interpret the world and understand the relationship between things. Mental models are deeply held beliefs about how the world works. 
For More , read Mental Models - Introduction

Stochastic Processes

Stochastic Processes - Mental Model Series -13

So much of life, it seems to me, is determined by pure randomness. Sidney Poitier

Photo by Pop & Zebra on Unsplash

Stochastic” means random, so we can call simply a “stochastic process”  as a random process.In the real word, uncertainty is a part of everyday life.Stochastic process helps us to understand them mathematically . As a process,it contains a wide variety of processes within itself in which the movement of an individual variable can be impossible to predict but can be thought through probabilistically only.

Movement of Exchange rates, Stock prices are good examples of stochastic processes. As we know , it’s not possible to predict stock prices on a day-to-day basis, but we can describe the probability of various distributions of their movements over time. Obviously, it is much more likely that the stock market (a stochastic process) will be up or down 1% in a day than up or down 10%, even though we can’t predict what tomorrow will bring.

Some important and simple stochastic processes  which can come handy while thinking in layman terms for you.

Markov Stochastic Process-

Remember :In Markov process,value of a variable does not depend on its historic values.Only the current value of the variable can be taken into account to predict the future values. In other words ,a process satisfies the Markov property if one can make predictions for the future of the process based solely on its present state just as well as one could knowing the process's full history, hence independently from such history(Memory less).

As a result, future predictions are expressed in probability distributions. Also , a variable might follow normal or log normal probability distribution.

It is important to understand that each probability distribution has a mean and variance where the mean is the average value and variance is the dispersion of values from its mean.

Mean is also known as return and variance is known as risk as it adds uncertainty in your variable’s values.

Consider the following example -

Imagine that there are two possible states for weather: sunny or cloudy. You can always directly observe the current weather state, and it is guaranteed to always be one of the two aforementioned states.

Now, you decide you want to be able to predict what the weather will be like tomorrow. Intuitively, you assume that there is an inherent transition in this process, in that the current weather has some bearing on what the next day’s weather will be. So, being the dedicated person that you are, you collect weather data over several years, and calculate that the chance of a sunny day occurring after a cloudy day is 0.25. You also note that, by extension, the chance of a cloudy day occurring after a cloudy day must be 0.75, since there are only two possible states.
You can now use this distribution to predict weather for days to come, based on what the current weather state is at the time.

Random walk -

The random walk theory is the occurrence of an event determined by a series of random movements - in other words, events that cannot be predicted. For example, one might consider a drunken person's path of walking to be a random walk because the person is impaired and his walk would not follow any predictable path.

The random walk theory as applied to stock trading,  the price of securities moves randomly (hence the name of the theory).Therefore, any attempt to predict future price movement, either through fundamental or technical analysis, is futile.So Stock traders is that it is impossible to outperform the overall market average other than by sheer chance. Those who subscribe to the random walk theory recommend using a “buy and hold” strategy.

Poisson process -

The Poisson process is one of the most widely-used counting processes. It is normally  used in scenarios where we are counting the occurrences of certain events that appear to happen at a certain rate, but completely at random (without a certain structure).

For example, suppose we know that earthquakes occur in a certain area with a rate of 2 per month from historical data. Other than this information, the timings of earthquakes seem to be completely random. In this scenario ,e Poisson process might be a good model for earthquakes.

 In practice, the Poisson process or its extensions have been used to model ,
− the number of car accidents at a site or in an area;
− the location of users in a wireless network;
− the requests for individual documents on a web server;
− the outbreak of wars;


At a higher level ,there are two ways to classify a stochastic process:

Discrete: When changes in value of a variable are at fixed points in time. Only certain values can be chosen for a discrete variable.
Continuous: When changes in value of a variable are continuous. Value of a continuous variable can take any value within a certain range.



Footnote -
What are Mental Models ?
“It’s your mind’s toolbox for making decisions. The more tools you have, the more equipped you are to make good decisions. “
A mental model is an explanation of how something works. It is a concept, framework, or worldview that you carry around in your mind to help you interpret the world and understand the relationship between things. Mental models are deeply held beliefs about how the world works. 
For More , read https://jamesclear.com/feynman-mental-models  

Randomness

Randomness - Mental Model Series - 12 

“Remember that nobody accepts randomness in his own success, only his failure.”- NN Taleb

  Ramdomness is the absence of patterns and predictability in events. But please note that
Individual random events are by definition unpredictable, but in many cases the frequency of different outcomes over a large number of events (or "trials") is predictable.

Randomness influence our personal and professional lives more than we realize. We normally forget many of those who fail and remember only the few who succeed. We then create reasons and patterns for their successes even though they are largely random . This is called by fooled-by -randomness effect . Nassim Taleb's book on this very subject is a classic and must read.

In his book , there are couple of quotes that stuck with my mind

• The only aspect of your life that fortune does not have control over is your behavior.
• Repetitiveness is key for determining if you are seeing skill or randomness at play. Can't repeat it? Not skillful.

He goes onto say something very important about probability too..

"Probability is not a mere computation of odds on the dice or more complicated variants; it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance. Outside of textbooks and casinos, probability almost never presents itself as a mathematical problem or a brain teaser. Mother nature does not tell you how many holes there are on the roulette table , nor does she deliver problems in a textbook way (in the real world one has to guess the problem more than the solution)."

Footnote -
What are Mental Models ?
“It’s your mind’s toolbox for making decisions. The more tools you have, the more equipped you are to make good decisions. “
A mental model is an explanation of how something works. It is a concept, framework, or worldview that you carry around in your mind to help you interpret the world and understand the relationship between things. Mental models are deeply held beliefs about how the world works. 
For More , read https://jamesclear.com/feynman-mental-models