Power law distributions

The last text was about Mediocristan and Extremistan. Let's forget the former and focus on the latter. Extremistan is a world in which the enormous outcomes are the results of small causes. 80/20 rule is the best known power-law distribution. It states that 80 percent of the outcomes come from 20 percent of the causes. This is just one power-law distribution and there are uncountable amounts of them. Do not focus on the 80/20 rule when you think about power-law distributions. Covid19-epidemic is an extreme example of a power-law distribution. Even though it is not sure, it likely started when one person ate some part of an animal he should not have. Millions of people will suffer from the virus.

The good, the bad and the irrelevant

It is not important to only understand that a minority of causes or inputs produce the majority of effects and outputs. Understanding that the majority of causes or inputs produce a minority of causes and outputs is equally important. Let's say that your causes and effects have 80/20 distribution. Then 80 percent of your causes and inputs are irrelevant. Their effects and outputs are close to zero. It is safe to say that 20 percent of your causes and inputs have large positive and negative effects and outputs. If your life is good, then your 20 percent has larger positive than negative effects. If your life is bad, the negative effects of that 20 percent are larger.

You do not have to be a rocket scientist to understand you have to enlarge the effects of positive causes and inputs in your life and diminish the negative ones. You can change to get rid of some of the irrelevant 80 percent of the causes and inputs. Change them into positives. It is unlikely you can get rid of all the negative causes and inputs. You can find ways to diminish some of the effects and outputs. You can transform some of them into irrelevant ones.

Long-term predictions are not smart in Extremistan

You can make predictions in Extremistan and be right for a short time, but the overall results of predictions are usually negative. As I mentioned in the last text, you need 100 billion fold data points in the 80/20 world compared to the normal distribution world. When the power-law distribution is 50/1, you cannot have enough data points or computing power to make any useful predictions. Financial markets and economies are parts of Extremistan. Therefore, an economist, financial pundit, or someone else who believes they can make exact predictions are idiots. Their total effect on the economy is negative. The funny thing is that they believe their predictive models are based on solid math. In short, do not believe anyone who believes they can make any useful long-term predictions in any social interactions. The world today is not predictable.

When predicting is not possible, you have to prepare for everything. How to do it is a whole another ball game. One way to deal with it is to reduce tight interactions. Do not use all your resources to achieve something like putting all of your time or other resources like money into one endeavor. Be less leveraged than you can. Have smaller debts than you can take. Be more independent. Rely less on other people and their resources. Have many income streams. Then you rely less on a single one.

Start making small experiments. Make small and numerous adjustments to your inputs. See what happens. There are lots of examples of what you can do. Make small changes in your marketing materials when you can do them in a cost-efficient way. Change a few words or colors, etc. Make small adjustments to your daily habits like your eating. See what happens if you diminish the availability of bad nutrition and increase the availability of a good one. Put some of your sweets (if you have them at home or work) into somewhere you cannot see them without increased effort in finding them.

Do you consider yourself a helpful person? If you found anything useful in this text, teach it to your friends.

Until next time,

-TT

Pareto´s law (80/20 rule)

Pareto´s law is a power law. You probably know 80/20 rule, but may have never heard of Pareto´s law. It is the same law. Pareto was an Italian social scientist who first noticed that 20 percent of the Italian population owned 80 percent of the assets in Italy. The inverse was also true, 80 percent of the people owned 20 percent of the assets. In reality, this rule should be restated. The better way to describe it is to say that ”A high proportion of effects come from a low proportion of causes or effort. For example, a small proportion of employees create the most added value to the company and its clients. 80/20 proportion can also be a 1/50, or 30/70, and other proportions. One of the most extreme proportions is that only a few percents of authors that write books sell almost all the books from the total amount of books sold.

Pareto´s law in human endeavors

A small proportion of employees add much more value than others. In simple tasks like machine users or employees in simple office work, the best one percent of the employees are three times more productive than the least productive one percent. In a little bit harder tasks like in retailing or mechanics, the best one percent are twelve times more productive than the last one percent. In the hardest occupations like insurance salesmen, sales negotiators, doctors, and lawyers, the most productive one percent were compared with average employees. The most productive one percent was twice as productive as an average employee. The biggest difference was between the best one percent of programmers and the average programmers and they were twelve times as productive as an average coder. Working with these people is one of the best ways of becoming more productive. If you are an employer, you have to pay these people a lot more than for average employees.

In business, a small number of products and clients can produce the most sales, profits, and losses. There are many examples, like Apple. Iphones bring the most profits and sales for the company. Apple has also many other products and other services. Many businesses have only one big client. When its business goes south, the subcontractor goes bankrupt. If you work for this subcontractor, your job is not as safe as a job in a business that has many clients. If this job is your only source of income, you might be in trouble, unless your expertise is needed elsewhere.

In investing, a small proportion of your investments bring you the most of your investment returns. And a small proportion of your investments bring the most of your losses. It is hard to know which investments bring losses in advance. Most people expect returns in all of their investments. This is a very unlikely turn of event. Only liars can do it. Beware of investing in businesses that have only one big client. When things go south you lose most of your money or all of them. Pareto´s law doesn´t only work with personal investing, it also works in stock indices. Most of the returns from stock indices come from a small number of stocks. And also most of the daily fluctuations have a small effect on indices. This means that few daily fluctuations have the most effect on stock indices.

A minority of your actions take most of your daily time. For example, you work approximately eight hours, sleep approximately from seven to nine hours, and watch television and spend time in social media both take a few hours a day. These actions take most of your time and the majority of actions like eating, exercising, commuting and other small tasks take a minority of your day. Most of your work effort goes to a minority amount of tasks, most of your time watching television goes to few numbers of channels or a few numbers of shows.

Some problems in using Pareto´s principle

Pareto´s principle is not easy to use. Most of the time you don´t know which efforts produce most of the results. Without the right measuring sticks, you can´t know. And it is hard to forecast which actions are crucial to get the best results. You need too many data points to forecast the future when Pareto´s rule is working. For example, according to Nassim Taleb, you need 10^15 data points to have any chance of understanding how these power laws like 20/80 rule work. You have to use a constant trial and error learning for a long time to achieve any meaningful results.

-TT