Unreasonable People and the Power Law: Three Quiz Questions That Exposed the Cracks in My Investing Instincts
Notes from reading the introduction to Sebastian Mallaby's The Power Law: three quiz questions that reveal the gap between a retail investor's instincts and how the power law actually works — hit rate vs. the single winner, mean reversion vs. watering weeds and cutting flowers, courage vs. position sizing. Pure reflection and method education; disclaimer at the end.
The great Peng bird rises one day with the wind,
whirling straight up ninety thousand li.
—— Li Bai, “To Li Yong” (High Tang, c. 8th century); translation mine
Notes from reading the introduction to Sebastian Mallaby’s The Power Law. This isn’t a book summary — it’s a record of getting schooled by a book.
First, three questions for you
Before you read on, answer three questions honestly — I answered them myself first, and I’ll lay my answers out for you in a moment.
Q1: A fund invests in 20 companies. Nineteen go to zero; only one returns 60x. Is this a good fund or a bad one?
Q2: You can add to only one stock: A is already up 3x, B is already down 40%. Which do you add to?
Q3: A life bet with a very high expected value but a real chance of total loss — do you dare to make it?
My answers: Q1, “bad.” Q2, “B, because price always reverts to the mean.” Q3, “no — I have a family to support.”
Looks reasonable, right? The book spends an entire chapter telling me: all three answers are wrong — and the way they’re wrong happens to expose the single brain most retail investors share.
Q1: You score by hit rate; the power law scores by “that one winner”
Just do the math: put in 20 units, 19 go to zero, one returns 60, and the whole fund triples. That’s not a bad fund — that’s top-tier venture capital.
The numbers in the book are even more extreme: across the seven thousand startups one fund-of-funds had backed, about 5% of the capital produced roughly six-tenths of all the returns. For a stretch, three-quarters of Y Combinator’s profits came from two companies out of more than two hundred. One winner pays for the whole table.
I answered “bad” because my head was running on a normal distribution: a 95% failure rate = bad. But the power-law world doesn’t look at hit rate — it looks at the size of the single winner.
The most ironic part is that my gut already knew. Ask me “which mistake hurts more: holding something to zero, or selling too early and missing a huge run?” and I answer “selling too early” without hesitation. There’s a stock I got off too soon, and the run that followed still stings to this day. My instinct was already standing on the power law’s side; only my math was stuck on the normal distribution. What this book does is force the two into alignment.
Q2: Watering the weeds, cutting the flowers
“The one that dropped 40% will bounce back; the one that’s up 3x has run enough” — the belief underneath that sentence is mean reversion: there’s a “proper middle” the world holds, and any deviation gets pulled back to it.
The venture world in the book is exactly the opposite: winners tend to keep winning. One venture capitalist held a company Cisco offered to buy — he thought the price was too low and refused to sell. A few months later, the number had been bid all the way up to $7 billion before the deal closed. He dared to hold because he knew that in a right-tail world, how good the good ones get will exceed everyone’s imagination.
And adding to the one down 40% while cutting the one up 3x is the very move the book despises most: watering the weeds and cutting the flowers.
This question was especially humbling for me, because I’ve spent hundreds of hours on quantitative backtesting, validating a pile of “sounds right” signals with a strict process (excluding survivorship bias, cross-model red-teaming against each other) — and moving-average signals were wiped out entirely, with no excess return whatsoever. The only two things that actually showed a real edge: avoiding the worst stocks, and staying close to companies whose fundamentals are improving at the same time.
In other words: my own data stands with the book, while my gut stands on the opposite side. Do you trust rules you spent hundreds of hours validating, or the knee-jerk “it’ll come back, right?”
Q3: The question isn’t courage — it’s position size
“No, I have a family to support” — the book doesn’t tell me to be brave. Bravery is the cheapest advice there is.
What the book gives is position design. Top venture capitalists dare to place absurd bets not because they have big guts, but because the structure protects them: “The most I can lose is one times my capital.” A single bet going to zero doesn’t touch their survival.
So the right way to open up Q3 isn’t the binary of “dare or don’t dare” — it’s a continuous dial: without harming the foundation, how small a bet can I set aside to chase that right tail? First get the foundation of your life solid (stable cash flow, not living off this money), then let a small bet take the risk. Between zero and a hundred, there are a lot of notches.
”All progress depends on the unreasonable man”
The “unreasonable” in the title comes from George Bernard Shaw: the reasonable man adapts himself to the world; the unreasonable one insists on making the world adapt to him — therefore all progress depends on the unreasonable man.
The venture capitalist’s version is more practical: the revolutions that truly matter cannot be predicted by extrapolating historical data. If tomorrow were just an extension of today, why bother predicting? True disruption, precisely because it disrupts so completely, can’t be extrapolated — it can only be discovered, round after round of experiment, never predicted.
One venture capitalist tests founders the other way around: instead of asking them to prove “this will definitely work,” he asks himself “can I find a reason it clearly won’t work?” — and if he can’t find one, it’s worth a bet. This is the same thing as the scientific spirit of falsifiability: don’t predict the future; design a mechanism that “dares to bet, and can also recognize when it’s wrong.”
Three questions to take with you
- When you evaluate your own portfolio, are you using hit rate, or whether the biggest winner pays for the whole table?
- Your most recent add — was it watering the weeds, or watering the flowers?
- That “high expected value but I don’t dare” bet in your life — is the problem really courage? Or have you just never seriously worked out “how small a bet would be painless even at total loss”?
Source: Sebastian Mallaby, The Power Law: Venture Capital and the Making of the New Future (2022); Traditional Chinese edition 《矽谷創投啟示錄》 (CommonWealth Publishing, 2022). This piece is a reading reflection and self-examination, and does not constitute any investment advice; the cases herein are personal experience, for educational reference only.
This article is an educational discussion of investment method. It is not advice to buy or sell any individual security, offers no target prices, and does not analyze any current holding. Investing carries risk; make your own decisions or consult a qualified professional.