Luck vs Skill in InvestingTanmay Gadre
Luck and skill play a part in investing. But the author Mr. Jeremy Chia says that many of us attribute our poor performance to luck and good ones to skill.
So, let’s learn more about luck and skill, shall we?
In a world full of unknowns and wide range of possibilities, luck plays a significant role in the final outcome. More than we want to believe. This wide range of possibilities can be seen in the profession of investing. Short term prices are volatile and random, and are influenced by luck. The long-term prices are also influenced by luck.
Long-term stock prices tend to be around the present value of the company’s expected future cash flow at the given time. The future cash flow is influenced by many factors. They result in a range of different cash flow possibilities. On many occasions, the market may also misprice certain securities. Hence, we should acknowledge that when it comes to investing, the future is not certain. There always will be a range of different possibilities.
The next step is to separate luck from skill. Skill in investing is hard to quantify. We need to analyse a sufficiently long track record. An investor can outperform his peers for decades rather than just a few years. Then the odds of skill playing a role become significantly higher. Warren Buffett may have been lucky in certain investments. But no-one can deny that his long-term track record is due to being a skilful investor.
How to identify?
Focus on the process. Analysing an investment manager’s process is a better way to judge the strategy. Compare his original investment thesis with the eventual outcome of the company. If they matched up, then the manager may by highly skilled in predicting possibilities and outcomes. Find a larger data set. Your investment strategy may be based largely on investing in just a few names. Then it is difficult to distinguish luck and skill because you’ve invested in only a few stocks. The sample is too small. But if you build a diversified portfolio and were right about the investments, then skill was more likely involved.
Our investing success comes down to both skill and luck. Hence it is hard to separate luck and skill.
Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”