Luck vs. Skill

Luck and skill are two sides of the same coin when it comes to investment. One cannot exist without the other playing a crucial role. Taking a trip down memory lane and utilizing dictionary definitions; skill is the ability to do something well and luck is when success or failure is brought about by chance rather than one’s own actions. Skill is easy to understand, you develop necessary traits to excel in your field of interest. Luck is more difficult to understand as it so readily creeps into our lives and can easily influence our successes and failures. Michael Mauboussin says there are three conditions for luck to exist over skill; the first being that it operates on an individual or organizational basis, the second that it can be good or bad, thirdly being it is reasonable to have expected a different outcome. It is easy to identify skill in sports, but when it comes to investing, luck easily creeps in and can alter the outcome and overshadow skills.

Identifying luck versus skill becomes a tricky part of investing and choosing a financial advisor. As luck and skill are often disguised by one another, Mauboussin gives an easy way to tell the difference. His suggestion to deciphering between luck and skill is to lose on purpose. Now, when it comes to your own money, losing on purpose or a financial advisor who loses is less than ideal. Fear not, investing is difficult to lose on purpose. Although it is difficult to build a portfolio that comes out ahead of its benchmark, it is far more difficult to intentionally build one to fall well below its benchmark. Which Mauboussin says is suggestive that investing is significantly more luck than skill.

Part of the reason investing is so luck driven, is that the stock market is run by chance. Short-term investments are greatly run by luck, as forecasting the one-year return on stocks is difficult at best due to them being a function of chance and outside situations that may occur. Long term investing still maintains a significant amount of luck but allows more skill to manage how it plays out. Over the long term, you are able to monitor not only the outcome but also the process used by the investors. Skilled investors will shake off the bad luck and less than desirable outcome and their sound process will eventually be in tune with luck for consistently positive results.

The perfect blend for a positive investment is good luck blended with expertise skills. Unfortunately, luck is not something that can be planned for and luck can also hide or amplify an investor’s skills. When it comes down to it, investors don’t know the future. Everyone must rely on luck and their individual process to work and hope for a positive outcome. The proper skills can make the investing process safer so that bad luck doesn’t keep you down and out. Begin your investment process by being aware of the potential losses. We are well aware of the potential gains or we wouldn’t be investing in the first place. Recognizing the potential loss and being defensive about your investments allows for the safest manner of gain along with armor against bad luck.

It is human nature to want to take the idea of luck out of investing. If you do well and show a positive return, you must be talented. If you do poorly and show a loss, you must be lacking the proper skills. Unfortunately, investment is not that simple. A loss does not mean you are unskilled, it may mean you were unlucky in the short term. A flawless portfolio may be indicative of a lucky but clueless investor whose statistical success will eventually run out.

When balancing luck versus skill, it is important to remember that, in the long run, skill will win over luck. Planning for the loss and investing defensively will guard against bad luck and will allow the time to develop your skills and further the potential for positive long-term gains.