Failure is the Best Teacher

In the aftermath of the unfortunate death of Steve Jobs, many have highlighted his brilliant 2005 commencement speech at Stanford.  I did too.  Jobs framed his speech around three stories from his life.

We’re all familiar with how these things are supposed to go.  Brilliant business executive explains his success by focusing on his success (it’s far too often a “he”) and encouraging us that we can make it too.

But Steve Jobs was anything but typical.

We all tend to be enamored with success and those that achieve it. We are all prone to what Nassim Taleb calls the “narrative fallacy.”  We want to see agency in the world.  We want to understand everything in terms of intent, but sometimes (many times) the “cause” is pure noise and worthless as a teacher.

The three stories Jobs chose to focus on at Stanford were difficult, heart-wrenching and painful:  dropping out of college; getting fired from Apple in 1985; and being diagnosed with cancer.  Success came from them, as Jobs explains, but only much later and after considerable struggle and difficulty. His approach was counterintuitive, but correct.  Thus, as usual, Steve Jobs was ahead of the curve.

By spending so much time looking at success, we learn the wrong lessons.  It is true, as Taleb concedes, that “chance favors the prepared.”  However, as Taleb also points out, those successes have as much to do with randomness and noise as with talent, plan and execution.  That’s a major reason why we are such bad forecasters.  As a consequence, we should be much more focused on failure than success, consistent with the philosophy of science developed by Karl Popper.

During World War II, England sent regular bombing raids into Germany. Many planes never returned and those that did were often riddled with damage from German anti-aircraft guns and fighters. Wanting to improve survivability, the English Air Ministry examined the locations of the bullet holes on the returned aircraft and proposed that reinforcement be added to those areas that showed the most damage.

The mathematician Abraham Wald, however, suggested otherwise (see his research here or read about it here).

Wald’s unique insight was that the holes from flak and bullets on the bombers that returned represented the areas where planes were able to absorb damage and survive. Since the data showed that there were similar areas on each returning B-29 showing no damage from enemy fire, Wald concluded that those areas (around the main cockpit and the fuel tanks) were the real weak spots and that they must be reinforced.

The more useful data was in the planes that were shot down, not the ones that survived, and had to be “gathered” by induction in that instance.  This insight lies behind what we now call survivorship bias – our tendency to include only successes in statistical analysis, skewing the results.

In most cases we’d be better served by looking closely at the stories of those who failed and why instead of the success stories, even though such people are unlikely to get great book contracts and six-figure advances.  Similarly, we’d be better served examining our personal investment failures than our successes.  That’s where the best data is and where the best insight may be inferred.

As I have noted before, investing is a loser’s game much of the time – with outcomes dominated by luck rather than skill, and high transaction costs.  If we avoid mistakes we will generally win.  By examining failure more closely, we’ll have a better chance of doing precisely that.

6 thoughts on “Failure is the Best Teacher

  1. Pingback: Tuesday 7atSeven: rebalancing risk | Abnormal Returns

  2. My profession is engineering failure analysis. My department doesn’t get any of the glory that goes to the designers and account teams, but we are fully staffed and well compensated so our management is clearly on the same page as you. Our bread and butter consists of accurate and timely fault diagnosis, combing through manufacturing data to identify potential screens, and working with our test lab to confirm the efficacy of corrective actions. I’ve never worked in finance, but I would guess that this approach would be easily adapted to work for investment portfolio management.

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