Common Sense 101: The difference between probability and possibility

Published: November 4, 2016 at 9:28 am

Last Updated on December 18, 2021 at 10:55 pm

The notion of risk and reward is key to any investment plan. However, our understanding and expectation of risk and reward are often clouded by an inability to distinguish between probability and possibility. Here are a couple of examples that hopefully might bring out the difference.

First some book news: Our new book, You can be rich too with goal-based investing is now an Amazon Best Seller! Thank you all fo your faith and support. If you have not yet ordered, find out more about the book and grab your copy today!

Can stock investors beat mutual fund managers?

First, does this question even make sense? Do people want guarantees before they start investing in stocks instead of mutual funds?!

It boils down to a matter of interest. I like something, I do it. I don’t, I don’t. Some of my choices can fail (if I choose to find out whether it did or not!) relative to other methods, but as long as I had fun doing it, and if my purpose is achieved, does it even matter?!


Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

Therefore, although the question does not make much sense, it can be used as an example to distinguish between probability and possibility.

Can stock investors beat mutual fund managers? A big resounding YES. As is the answer to “Can we reach the top of mount Everest?”. (No, I am not saying it is that hard, hang on).

As is the answer to “Can we reach the top of mount Everest?”. No, I am not saying beating funds is that hard, that would be a disrespect to the mountaineers. Hang on.

YES,  because the question is referring to the possibility of an event happening. So the answer is, “Yes, it is possible”.

Of course, this is extremely unhelpful. A better question to ask is,

“What does it take to beat an equity mutual fund manager?”.

Since something is possible, a set of steps to accomplish it can be stated. No issues there.

This does not mean the task is easy or hard. This does not mean, anyone who follows these instructions will achieve success and others would fail.

The answer to “Can stock investors beat mutual fund managers?” is not an off the cuff,

  • “it is hard”;
  • “it is easy”;
  • “I did it (and therefore no one can!)”;
  • “I could not do it (and therefore no one can!)” etc..

Simply because one requires data to gauge hard or easy. What data?

A study of, say about 100 (or more) stock investors vs a equal number of mutual fund investors who buy on the same days for a long enough period of time (say ten years) and repeat this experiment at least a few times over different time periods to calculate the probability of success or failure.

Even then, it is the probability of past performance! Even the choice of mutual funds to compare should not have biases (an index can be used). Even then all we can do is to state the result of the above study, assuming it is available and assuming the investors chosen had an IQ that was neither too low nor too high and reasonable common sense.

That sounds awful does it not?! Who will do such a study? Is it not easier to extrapolate our lone experience or the experience of a couple of people we know and make statements like, “it is unlikely”, “it is likely” etc? Many, including me, are guilty of such extrapolations.

Probability is the result of an unbiased and relevant study. Not a lazy extrapolation.

An unbiased study with statistically significant data.

I know, I know, it is academic nonsense that many disrespect without even a clue about what it stands for.

Assuming such a study is available for the above situation, should I extrapolate the results and decide to invest or not invest in direct equity? Possibly! With the understanding that

  1. Such results are often far from perfect and may not represent an actual probability – even if it is calculated like one!
  2. Even if the result shows 99% of investors could beat fund managers, it is possible that you could be part of the 1% who did not!

Just because an positive outcome has high proability, it does not exclude the possibility of a negative outcome! And vice versa. Example – LICs high claim settlement ratio!!

Related post: The difference between stock investing and mutual fund investing.

My point is, before worrying about an answer, we should first understand the difference between:

what is the probability that stocks investors can beat fund managers?

what is the possibility that stocks investors can beat fund managers

Since the questions are different, so are the answers!

Probability can only stem from  a big enough data set, not a single or few instances.

Possibility can be met with a simple (in this case) “yes, one can beat mutual fund returns with direct equity” even if a single investor* managed to beat a fund manager (over the same duration+dates).

* Many have, but since there is no systematic study associated, one cannot talk about a probability.

Even if no one managed to ascend mount Everest, it cannot technically be declared as impossible! It would just be very, very tough to climb. (More than 4000 people have managed to climb, but 280+ have died trying, so it is still very very tough!). Let me repeat, there is no correlation made between beating a fund manager and climbing mount Everest. That would be a disrespect to the mountaineers.

probability-vs-possibility

Probability can be high or low. Possibility is only a yes or no.

(hey it rhymes!)

A probability of 0% = impossible (black).

A probability of 100% = certain (white). The answer to the above question could be anything from 0% to 100% (shades of grey), depending on the decisions we make!!

Technically, there is no such thing as highly possible or very possible! That is just lack of data speaking! Either we have data or we don’t and stick to possibilities.

Here are two more example to highlight this point:

Can equity investing beat inflation?

If I were a salesman, I will say “most definitely” and move on. Unfortunately, I am not. So I am compelled to point out the difference between

Can equity investing beat inflation?  –> Yes, it is possible.

Will equity investing beat inflation? –> Yes, it is probable (by how much is grey area!!).

For both answers, the following rejoinder can be added:

Past performance reveals plenty of occasions when equity returns were less than fixed income returns and therefore active risk management is essential.

Is health insurance necessary?

Some people believe that health insurance is an expense and not very useful because the probability of a big-ticket hospital expense is low and that they can handle common hospitalisations without insurance.  This is again a confusion between probability and possibility.

Other examples

  • Will a SIP work?
  • Will going to a financial planner fetch me better returns?
  • Will my claim not be rejected if I buy from LIC?
  • Will DIY work? (like they say, everyone can DIY, but not everyone should!!). Read more: Reader Story: Are you sure you can be a DIY investor?
  • Equity funds returns 25% in the past and therefore history will repeat itself.
  • Why should I not invest in 100% equity since it will anyway give better returns in the long run?
Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.

  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter with the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

Explore the site! Search among our 2000+ articles for information and insight!

About The Author

Pattabiraman editor freefincalDr. M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter, Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu gets a superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl version covers of Chinchu gets a superpower.
Most investor problems can be traced to a lack of informed decision-making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it and teach him several key ideas of decision-making and money management is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & it's content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)