The role of Luck in investing

By Larissa Fernand |  17-02-20 | 

South African professional golfer Gary Player was famed for saying, “the harder I practice, the luckier I get”. This fine line between the nurturing of skill and the randomness of luck has great importance in investing.

I recently wrote about it in How social influence affects our decisions and Skill or Luck?where I share the views of Michael Mauboussin. Years ago, in an interview with Forbes, Mauboussin of Credit Suisse shared his perspective: "Investing is interesting because it is difficult to build a portfolio that does a lot better than the benchmark. But it is also actually very hard to build a portfolio that does a lot worse than the benchmark. What that tells you is that investing is pretty far over to the luck side of the continuum."

I have also written extensively about Shankar Sharma's stock picking strategy; how he made money on the Amazon stock and how he made money on the Twitter stock. The vice chairman and joint managing director of First Global has always propagated that investing is “90% luck, 10% skill.”

Here’s what he means:

You can get into a good trade. You can make a bit of money. But to make 100x your investments requires a dose of good old-fashioned luck. Nobody could have predicted the stellar rise of the above mentioned stocks. I doubt if the management at IndusInd Bank thought that one fine day their market cap would be what it is now. That part is luck. To capitalize on that luck, you need skills, you need to do your homework – that is the 10%. Hence, I say, investing is 90% luck. But you cannot get lucky if you don’t put in the hard work of 10%.

On this subject, Nick Maggiulli wrote a brilliant post in his blog Of Dollars and Data. An excerpt has been reproduced below.

In the late 1970s the view in the publishing world was that an author should never produce more than one book a year. The thinking was that publishing more than one book a year would dilute the brand name of the author. However, this was a bit of a problem for Stephen King, who was writing books at a rate of two per year. Instead of slowing down, King decided to publish his additional works under the pen name of Richard Bachman.

Over the next few years, every book King published sold millions, while Richard Bachman remained relatively unknown. King was a legend. Bachman a nobody. However, this all changed when a book store clerk in Washington, D.C. named Steve Brown noticed the similarity of writing styles between King and Bachman. After being confronted with the evidence, King confessed and agreed to an interview with Brown a few weeks later. The Click Moment: Seizing Opportunity in an Unpredictable World tells the story of what happened next:

In 1986, once the secret was out, King re-released all of Bachman’s published works under his real name and they skyrocketed up bestseller lists. The first run of Thinner had sold 28,000 copies the most of any Bachman book and above average for an author. The moment it became known that Richard Bachman was Stephen King, however, the Bachman books took off with sales quickly reaching 3 million copies.

This phenomenon isn’t exclusive to Stephen King either. J.K. Rowling published a book called The Cuckoo’s Calling under the pen name Robert Galbraith only to be outed by someone performing advanced text analysis with a computer. Shortly after the public discovered Galbraith was Rowling, The Cuckoo’s Calling increased in sales by over 150,000% shooting to the #3 on Amazon’s bestseller list after previously being ranked 4,709th.

Both King and Rowling’s foray into undercover writing reveals a harsh truth about success and social status — winners keep winning.

This idea is formally known as cumulative advantage, or the Matthew effect, and explains how those who start with an advantage relative to others can retain that advantage over long periods of time. This effect has also been shown to describe how music gets popular, but applies to any domain that can result in fame or social status. I discovered this concept by reading Michael Mauboussin’s The Success Equation where he writes:

The Matthew effect explains how two people can start in nearly the same place and end up worlds apart. In these kinds of systems, initial conditions matter. And as time goes on, they matter more and more.

This explains how King and Rowling sell millions while Bachman and Galbraith don’t, despite being of similar quality.

What can you do about it?

Think about the story you tell yourself about yourself.

In all the lives you could be living, in all of the worlds you could simulate, how much did luck play a role in this one?

Have you gotten more than your fair share? Have you had to deal with more struggles than most? I ask you this question because accepting luck as a primary determinant in your life is one of the most freeing ways to view the world.

Why? Because when you realize the magnitude of happenstance and serendipity in your life, you can stop judging yourself on your outcomes and start focusing on your efforts. It’s the only thing you can control.

I know this because I have had far more luck than most. Most lower-middle class kids growing up with divorced parents don’t get the chance to get a full ride to a top university. And even fewer ever find their passion and get to do it everyday. However, I’ve always tried to work hard and that’s where I get my satisfaction.

So don’t let good luck put you on a pedestal, but don’t let bad luck knock you down either. Because for every Stephen King there is a Richard Bachman that never saw the light of day.

Yes, some of us are born with more advantages than others and some of us are born with less, but you should never let that define how hard you try.

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Ronak Raichura
Feb 20 2020 05:11 PM
 Excellent Article. Keep writing them.
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