Sunday, June 15, 2014

Applying Pascal's Wager on Investment Decision

I am reflecting on my recent investment decision to add on my position in UMS instead of reducing my exposure in view of the potential risk suggested by the major shareholders' stake sales. It seems counter-intuitive.

I believe there are many times when we bought a stock and had our convictions tested with negative news. Despite doing all the due diligence to avoid pit-falls prior to our decision-making, risk can never be eliminated. Depending on the outcome, the decision made can be seemed to be a wise or foolish one.

There is a concept in Game Theory called Pascal's Wager. We can look at the possible scenerios to see if decision to stay vested is a viable one:
  1. Believe in UMS fundamentals and UMS turns good: Good for me (+3)
  2. Believe in UMS fundamentals and UMS turns bad: This is bad for me (-2)
  3. Don't believe in UMS and UMS turns good: Sold for some profit and miss out on the recovery run - No damage actually (0)
  4. Don't believe in UMS and UMS turns bad: Sold for some profit and no damage on further downside (0)

Points are added to the back of the actions and possible outcomes. A higher positive number means a better outcome and a negative one means a bad outcome. For the scenerio where I believe in UMS fundamentals and stay vested, I do better when the company turns out good (+3), rather than when it turns out bad (-2). Reason being, I am able to set an exit strategy. Simply buy and hold without having an exit strategy would be unwise.

For scenerio where I don't believe in UMS fundamentals, there is no difference as both give a 0.

My simple conclusion: Stay vested. Of course, this is too simplistic. It all lands on weighting the risks and rewards.

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