How Statistics Can Confuse Investors

Common statistics hold plenty of pitfalls for investors; using properly constructed statistics, but in the absence of other relevant facts, can lead to poor decisions

Paul D. Kaplan 13 April, 2018 | 12:36PM
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Quoting Benjamin Disraeli, Mark Twain famously quipped, “There are three kinds of lies: lies, damned lies, and statistics.” In the field of investments, in which we rely heavily on statistical analysis to evaluate the merits of investment strategies and products, Twain’s point is all too relevant.

Correlation Is Not Causation

One statistic that is all too easy to be misleading is correlation, starting with its definition. How many times have we heard that correlation measures the tendency for two variables to move up and down together? That’s not quite right. What correlation actually measures is the degree to which two variables, each in excess of its own average, are statistically related.

The other major mistake often made with respect to correlation is causation. Seeing that two variables are statistically related, we too easily jump to the conclusion that there is a causal relationship between them. But correlation and causation are two very different things.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Paul D. Kaplan  Paul D. Kaplan, Ph.D., CFA, is director of research with Morningstar Canada.

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