Has your investment success so far has been based on luck? If so you are unlikely to be successful over the long term as at some point your luck will run out, most likely when the bull market ends. But how do you know if you have been lucky or if your investment success is based on skill? It’s easy to confuse the two. And I am sure you have never met an investor that has said his success is only based on luck. So how do you determine if you are a skilled investor? Knowing the difference is especially important if you invest in funds. You want to determine, preferably before you invest, if your fund manager’s track record is based on luck or if she is really a skilled investor.
I have read and thought about how to tell skill and luck apart a lot. Not because I wanted to apply it on someone else. I wanted to know if I have so far just been lucky or if I have some skill as an investor. For if I have just been lucky I want to give my money to someone skilful as soon as possible before I lose everything. The best writing on the subject I could find is an article by someone I admire and have followed since at least 2004.
His name is Michael Mauboussin and he is chief investment strategist at Legg-Mason Capital Management Inc. You can find more articles by Michael here: Michael Mauboussin resource page. In the article Untangling Skill and Luck – How to Think About Outcomes – Past, Present, and Future published in July 2010 Michael says:
“Outcomes from many activities—including sports, business, and investing—are the combination of skill and luck. Most people recognize that skill and luck play a role in results, yet they have a poor sense of the relative contribution of each. The ability to properly untangle skill and luck leads to much better thinking about most day-to-day outcomes, and allows for sharply improved decision making.”
The article is quite long, 27 pages, but definitely worth reading as in it he goes on to show:
- Why it’s important to think about the blend of skill and luck in an outcome
- How to determine the blend of luck and skill
- How to sort skill and luck in sports, business and…
