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23 February 2015

Getting it Right, the Wrong Way: the Gump Trap

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Both in our professional and personal/family lives, we try to identify and measure risks; we assess the alternatives; we choose the best option and make sure that it is implemented correctly; and we check whether or not it was successful. If you would like more information about this decision-making process, I recommend Descartes’ Error by António Damásio.

Given how complex the decision-making process is and how it can be continuously improved, we often forget that evaluating the result is not always of trivial importance.

If we made the right decision, in other words, if the risk has been mitigated or if we have obtained the desired profitability, there is positive reinforcement. This reinforcement impacts both ourselves (as I mentioned in our last post, it reinforces our personality), and the quality of the decision-making process.

However, this positive reinforcement is not always beneficial.

Forrest Gump (Robert Zemeckis, 1994) won six Oscars and tells us the story of a simple man with a big heart whose (good or bad) luck takes him through the main events of his time.

At one point in the movie, Forrest Gump says that he invested in some kind of fruit company with an apple. He naturally means Apple Inc. The idea is that Forrest Gump becomes incredibly rich by unknowingly investing in one of the most profitable companies in the world. Less fortunate events also result from unintentional decisions.

Forrest Gump makes an investment decision based on inadequate or misinterpreted information. The movie gives the impression that the character was lucky and became a millionaire even though his decision was based on incorrect reasoning.

An investor like Forrest Gump may assume that he made the right decision by following an appropriate decision-making process. And this is the Gump trap, the fallacy of believing that mere luck is actually skill.

This trap is very common among business managers and financial investors. The Gum Trap means that we believe that past successes are only due to us, while our mistakes are due to several factors. The classic “I have passed the test” vs. “The teacher flunked me”.

We need to be aware that luck (called ” stochastic component” in risk management) exists to a greater extent that we are willing to acknowledge, and that it has both a positive and negative impact.

Let’s now look at what really happened with Apple’s share price.

The novel “Forrest Gump” was published in 1986, so we can assume that it was written in 1985 which, paradoxically, was a bad year for Apple. This reference to Apple may have been added to the movie’s script (I have not read the book by Winston Groom) as Apple’s shares in 1985 were below the IPO price (December 1980).

On its release in 1994 the movie was a huge success. In 2004, an article in the New York Times details this paradox in the context of Apple’s 1994 share price: although the stock had doubled since 1981, there was still no reason for great excitement, and there were more profitable options.

The NYT article’s author explains that Forrest Gump actually made the wrong decision, and that his investment did not meet expectations.

But this article is from 2004, just before the iPod became the 21st century Walkman.

Nowadays Apple is listed at 112 dollars vs. its original 3.6 dollar offering price. Actually, 112 dollars after a 1:7 split (seven new stocks for each new stock) in June 2014 (its share price was 700 dollars at the time…). Google Finance shows its progress compared with Dow Jones and NASDAQ (see here), i.e. an increase of 21,842% (yes, twenty-one thousand).

So, Forrest Gump did get it right with Apple…in the long term. Based on wrong premises and using a defective decision-making process, he made the right decision.

Our brain is designed to find causalities. This can make us believe that there is a relationship when there is actually none. Even when we are successful in our business or investment activity, we must consider whether the decision was all our own or was born of chance. And this is one of the most complex tasks ever. It is very difficult to assume that mistakes are our fault. However, acknowledging that we have played no role in our successes is even more complicated. Our brain does not tend to be so humble, as I mentioned in the previous post.

Let’s not follow Forrest Gump’s example. When we fail, let’s check what went wrong. And when we get it right, let’s not forget that luck sometimes helps us but does not make us better.

Pedro Agudo


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