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Gambler's Fallacy

The Gambler's Fallacy is a mistaken belief about sequences of random events. It is easy to both spot and engage in subconsciously. If we flipped a coin 10 times in a row and it came up tails every time, would you be secretly tempted to wager that the next flip should result in heads? It has to be more likely to come up heads next time, right? The unlikely odds of 10 tails in a row means heads must be due.

Except it is not. Each flip is an independent event and the odds remain 50 – 50, regardless of the previous results. With investment and financial decisions, we often see people erroneously apply this to market directionality. If the market has been up for several years, we must be due for a correction. Or if a stock has performed poorly, it must be due for a comeback. In reality, investment outcomes are not time based. They are based on economic conditions, the business cycle, and company performance. We can have extremely short or long market cycles. The only verifiable time-based observation we can make is that markets tend to rise over long periods of time.

To avoid falling victim to the gambler’s fallacy, remember to evaluate the likelihood of a potential outcome on its own merits, not a time period. In terms of investments, that means not trying to time markets, and if you must make an allocation decision steer clear of this line of reasoning.

This is not a recommendation and is not intended to be taken as a recommendation. This material was prepared for general distribution and is not directed to a specific individual.

LPWM LLC does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers.