Something true about business and life is the power law. If you think back to the various undertakings you’ve begun in life, you might find there were a lot of false starts and weak fizzles. Maybe that budget you were trying to stick to somehow didn’t survive the first three-day weekend that came along. Or perhaps that goal to start law school next year never really materialized.
These are things you didn’t do, but what about the things that you do execute on? Instead of law school, maybe you continue to be an above-average police officer. From that, you can safely infer that your past efforts around becoming good police are producing an outsized impact on your life – compared to say, those two months you studied for the LSAT.
Some call this the Pareto principle – the “80-20” rule – but statistics has a name for it too: the power law.
We intuitively grasp this concept when we name it the 80-20 rule, and the idea is basically the same. There are also enough naturally-occurring examples to give the power law a certain magistracy that hints at a deeper truth. But more immediately, isn’t it funny that so much of the advice we hear in business and investing contradict this straightforward thought?
It is a truth universally accepted that in investing you must diversify. Don’t keep all your eggs in one basket. Following that belief, you park some money in AT&T, some in Google, a bit more in Tesla, and maybe even a little in Phillip Morris International (though you probably don’t brag about that last one at cocktail parties).
The idea underlying all this is that if Google suddenly experiences some turn of fortune and tanks, you still have AT&T and the others humming along and making you money. Statistically though, this may give you only decent returns – sadly you’ll never retire off this milquetoast approach. If that is your goal, you need to seek grand slams, not singles and doubles.
For example, in 1998, would you rather invest $250K equally across the top ten biggest companies of the year (including General Motors, Ford, IBM, and Chrysler), or would you want to plow that into a nascent company called Google? Jeff Bezos decided to do the latter, and when Google went public in 2004, that $250K investment resulted in a return of over $280 million!
The power law has interesting repercussions for not only investing but for life in general. Maybe by forcing it to the front of our thoughts, we can harness what that means.