Investment Success: Luck vs Skill
As a geologist I have long been interested in the contribution of luck to exploration success. It is much more important than many people wish to believe. At BHP we used to say, only half-jokingly, that it would be more cost effective to just drill Australia on a grid than to undertake structured exploration programs.
On the subject of luck, I have just finished reading a book by Michael Mauboussin about “Untangling skill and luck in business, sports, and investing.” (full details below). Michael is Head of Global Financial Strategies for Credit Suisse Group AG. He has written several books on investing.
The book relies heavily on statistics along with healthy doses of human psychology. I will cover, in a general way, a few of the many subjects he covers below. Read the book for his supporting arguments and the math.
The Paradox of Skill
As the skill of participants improves in a particular endeavour, luck becomes more important. This is certainly so in investment. With the exception of a few outstanding individuals, investment success, particularly over the short term, is mostly about luck.
To be truly successful, you not only need very good skills, but a good supply of luck.
Luck in Sports
Michael uses statistical proofs to place activities on the continuum of luck vs skill. He focusses on sports because there are much more measureable data available. Thus he estimates that luck only contributes 12% to success in NBA basketball, whereas it contributes 53% to NHL hockey outcomes.
Age and Performance
Bad luck for some here. The peak age for investment skill is around 42, by the age of 70 there is a sharp drop in investment performance. This does not of course apply to outliers such as Warren Buffet.
IQ vs RQ
Smart people do dumb things. A high IQ does not necessarily correlate with cognitive skill. Prof. Keith Stanovich, of the University of Toronto, has demonstrated that IQ is a distinct ability, quite separate to what he calls Rationality Quotient. RQ is about cognitive skills, such as decision making and goal setting.
Self-Serving Attribution Bias
We tend to attribute any success to our fabulous skill set and any failures to bad luck. Quite the recipe for bad decision making. Being aware of this fact can help the decision making process.
Heuristics and Biases
It has been shown that many people tend to make decisions on an intuitive basis, with predictably poor results. More analysis and less guesswork.
Most people will not play NBA basketball and most investors will not make a fortune. However a deeper understanding of skill vs luck would be a great advantage. Read the book.
The Success Equation
Untangling skill and luck in business, sports, and investing
Michael J Mauboussin
Harvard Business Review Press