Luck Or Skill - What Is More Critical To An Exceptional Investor (Or Even A Completely Worthless One)?

The age old debate of whether luck or skill is more important for an investors'a success will likely never be resolved, although the attached presentation by Legg Mason's Michael Mauboussin provides some colorful anecdotes to validate the view of either side of the polemic. To be sure, working with someone like Bill Miller, Michael must be all too aware of just how prominent a role luck plays (or at least decade long leveraging into a cheap market bull run, only to see all your profits and reputation evaporate overnight when it all comes crashing down), which is precisely why his conclusion tends to veer on the side of skill. Obviously, when dealing with such concepts that have Gaussian distributions, as stocks increasingly demonstrate fractal features (courtesy of HFT), the whole debate is becoming increasingly moot. Yet Mauboussin does have an interesting discussion on reversion to the mean phenomena: something which in a world of near 1.000 implied correlation is of huge and often underestimated, significance: "We have mentioned already that reversion to the mean ensnares a lot of decision makers. This is
so important for investors, however, that it bears additional comment. The sad fact is that there is significant evidence that investors—both individual and institutional—fail to recognize and reflect reversion to the mean in their decisions. To illustrate, the S&P 500 Index generated  returns of 8.2 percent in the twenty years ended 2009. The average mutual fund saw returns of about 7 percent, reflecting the performance drag of fees. But the average investor earned a return of less than 6 percent, about two-thirds of the market’s return. The reason investors did worse than the average fund is bad timing: they put money in when markets (or funds) were doing well and pulled money out when markets (or funds) were doing poorly. This is the opposite of the behavior you would expect from investors who understand reversion to the mean." Ironically, investors have learned their lessons: after a nearly 60% ramp from the all time lows, investors continue to refuse to buy when everyone else is buying, contrary to the pleading by Obama, and all the conflicted fly by night permabullish mutual fund managers which CNBC appears to have an infinite collection of to recycle and fill content inbetween all those incontinence ads 24/7.

Comments

[schoolsout]

I'm the best trader ever....EVER!  I just have bad timing...and the gov't going against me from what seems to be every damn angle!

That's my theory, at least...

[IrishSamurai]

Political connections ... FTW.

[Hansel]

+1, inside information always helps too

[Amos Moses]

The key to trading is being skilled enough to be lucky!

[Jason T]

Question should be:

What's the less immoral way to make money today:  inside information or using your banks deposits to front run your brokerage client's orders?

[hedgeless_horseman]

Stock trading and most other forms of intermediation are dead to me.  Sorry, Mr President.  Neither do I gamble in casinos, count on the police to keep me safe, get paid by the government, use an investment advisor, use a realtor, or lend to banks. 

I do raise my own horses, beef, chickens, rabbits, vegetables, fruits, and nuts.  Our milking shorthorn produces milk and cheese. 

I do support these intermediaries:  wheat, rice, corn and bean farmers; brewers; distillers; wine makers; saddle-makers; tanners; tailors; miners; oil companies; wind turbine companies; car makers; surgeons; steel makers; armorers; timber growers; soldiers; sailors; airmen; software developers; pc makers; bloggers; school teachers; musicians; and a church.

I don't watch TV. I see more sunrises and sunsets than most people.  My wife, kids, and I have dinner together almost every night.

Much of the above was not true less than five years ago.  Rahm was right about crisis.

[Jason T]

Love this!  This is part of our economic disintegration.  I'm working towards that way of life too.  Can't wait to start brewing own beer like Thomas Jefferson.

[hedgeless_horseman]

I'll drink to that! 

In my experience, here are three excellent places to start:

http://www.ideal-poultry.com/

http://www.simplepump.com/

http://hambydairysupply.com/xcart/product.php?productid=1901&cat=0&page=1&featured

[Oh regional Indian]

Didn't the monkeys that threw darts and beat a bunch of street-pros solve this issue once and for all?

Also, having the right instinct is one thing, pulling the trigger on that knowledge is a whole other one.

I think you need instincts, courage of conviction and patience.

Or an uncle on the board.

ORI

http://aadivaahan.wordpress.com

[Village Idiot]

"Didn't the monkeys that threw darts and beat a bunch of street-pros"

Yes, monkeys beat most traders - I hired one.  Bananas and diapers tend to be a drag on performance, however.

[contrabandista13]

"...... I hired one......"

Funny you should say that....  We hired a whole bunch of them and called them our Risk Management Team.....

Ciao

[contrabandista13]

"...... I hired one......"

Funny you should say that....  We hired a whole bunch of them and called them our Risk Management Team.....

Ciao

[Oh regional Indian]

:-)

ORI

http://aadivaahan.wordpress.com

[ZakuKommander]

A good algo.

[newstreet]

1) Don't let a winner turn into a loser.

2) Let winners run.

3) Cut losers.

4) Sell Euros above 130.

5) Pay no attention to the above trading rules and get killed on the EU trade.

[Nolsgrad]

Here's that money flow thing TD posts but this one is since 2007

http://www.scribd.com/doc/34935895/Money-Flows

Data source

http://www.ici.org/pdf/flows_data_2010.pdf

*note June is not final data and July isn't complete yet. Basically says investors suck it.

[AR]

Can anyone provide a PDF LINK (who has it) to the above Legg Mason Report?  Thanks very much (if it's available).

[Nolsgrad]

It's called the download button.

[Cognitive Dissonance]

Some people working in offices with restricted/controlled/blocked computers can't see the pictures and attachments to the articles. Or they are restricted from certain web sites such a scribd.com. Since the download button is within the picture, that download button your see so clearly is missing for others or they can't get to the scribd web site to log in and download.

[Nolsgrad]

man that's got to be annoying. Thanks for the info CD.

[AccreditedEYE]

http://www.lmcm.com/pdf/UntanglingSkillandLuck.pdf

[AR]

AccreditedEYE -- thank you very much.  We appreciate you helping out. We have a strict privacy policy that we cannot submit our email to unknown public sites.  Thank you again... You're a good man (or gal).

[AccreditedEYE]

NP. (man, once I get a hold of The Precious...)

[economessed]

Mean reversion?  To which mean?  Looking at the long-term market mean, we are going to revert down.  Shorten the time frame to the last few years, and it looks like we are going to revert up.

Here we go again -- another fact-free discussion of "how the market works" rationalizing why some/many individual traders underperformed an arbitrary benchmark.  There is no pre-ordained mean (path) the market is on.  It's yet another mathematical construct.

There remains no accountability or consequences for fact-free conversations, so feel at liberty to say whatever you like.  That's why we still need the Latin language, because there is no substitute for caveat emptor.

[Astute Investor]

Well, I don't believe in luck.  I believe that, to a certain degree, a man makes his own luck.

Frank Savage

[carbonmutant]

Being on Bennie's rolodex...

[Gordon_Gekko]

This is unrelated, but one of my readers just alerted me to this. Too hard not to share with y'all:

Karl Denninger just F**KED ALL his sorry tickerforum's commenters in the ass.

http://tickerforum.org/akcs-www?post=143529

Nice going Karl! Even I didn't think you could fall to such depths. Here is a comment from one of the forum's commenters:

After racking up nearly 2,000 posts since joining TF in 2007, about 4 months ago I changed the password of my account to something I randomly typed into notepad so that I could never login to it again.

This is my first post with the account I created some time ago for the sole purposes of searching for posts on TF.

Here is my advice - never post anything on Ticker Forum again. Karl basically built this entire forum on the backs of people posting copyrighted material in its entirety. Anyone remember the weekly Saturday postings with full text from Barron's? That's just one example. That type of things was actively encouraged. Now that the heat gets turned up, he tells us all, "Not only will someone else come after you, I will come after you."

I came to the conclusion several months ago that TF was best read and not posted to. And I think many others have come to that conclusion as well.

Rest assured that Karl can in fact delete users and posts from the forum. It's called a cascading delete where any child record possessing a foreign key that matches the primary key being deleted is likewise deleted. He won't do it though because frankly his entire forum is built on posting copyrighted information.

Also rest assured that if Karl DID allow you to remove the copyrighted material, any damages awarded to the copyright holder would certainly be lessened. In fact, I would wager they would stop the action because there would be no continuing harm.

The entire thread is worth a read though.

[Canucklehead]

I just have to chuckle.  Karl must have busted you good. 

As you likely know you can't please 5% of the people.  I suspect you are part of Karl's 5% club.  You are probably in the thousands over at the Ticker Forum site.

How big is the 5% club at your site?

[b_thunder]

Is it a luck or a skill to be in a position to:

A) Know what the Fed's next move going to be (GS, JPM)

B) Have your men in the US Treasury working for you? (GS, BlackRock, PIMCO, etc)

[lieutenantjohnchard]

this article cannot be right. it says that the best investors sell into strength which means that the best investors turn bearish at the top of the market. then they buy low, rinse and repeat. but as i've been advised by no mas trabajo on these pages bears are "always" wrong, and "idiots."

this is all so confusing. how can the best investors be "always" wrong, and "idiots" as well?

i will await more revelations from no mas trabajo so that i too can grow my portfolio to four digits like him/her/transgender/neither gender/all genders.

[Bankster T Cubed]

the secret is in doing the opposite of what sell-side strategists advise

seriously

[Bankster T Cubed]

forgot to mention the #1 reason some people at the banks especially outperform:  INSIDER INFO

[unionbroker]

all you have to do is remember that 1% of the population owns or controls 80% of the stock so figure it out.

[No More Bubbles]

Ironically, investors have learned their lessons: after a nearly 60% ramp from the all time lows, investors continue to refuse to buy

Don't worry, they will capitulate at the highs and get back in.  They ALWAYS do.  The crooks will take this up as far as they must to guarantee it happens.......

WATCH!

[chrispycrunch]

Luck vs skill is best summarized with this pic:

http://www.ritholtz.com/blog/2010/07/skill-vs-luck/

[technovelist]

Timing is luck, strategy is skill.

[NotApplicable]

How can gambling in a casino be considered investing? Interestingly enough though, the luck vs. skill argument still holds true.

[anony]

There is the third alternative to luck and skill, 'ow bout Securities Fraud?

http://www.cnbc.com/id/38428884

[vxpatel]

Since 1999, when the DJIA first hit 10,000 we've spent almost all of our time either going up a bubble or falling off one, only to end up right where we started. By DOW 10,000 Apple, Google, Microsoft, Intel, the internet, every type of financial innovation, wireless internet, satellite navigation, and almost every other thing we take for granted had already been priced into the market. In fact, we've bee firmly lodged in tiny trading range since then. Lost decade? I don't think so, it's already been a lost decade, we are looking at 2 lost decades...as a direct result of 2 bubbles. Here's a look at how this decade plays out in trading days: There have been 2,848 trading days since the DJIA first crossed 10,000 on 3/29/09 . Since then it's been below 9K 426 days, or 15% of the time, it's been above 11K 779 days, or 27% of the time, it's been between 9K - 11K for 1,643 days or 58% of the time. Meanwhile, your 401k money has been buying on all those days, when in reality it would have only made sense to purchase on days when the DOW was below 9K or about 426 opportunities to get stocks at a good price. In other words, you had ample opportunity to purchase stocks on a more reasonable basis, than not. So why would you mindlessly purchase stocks each month?

[hedgeless_horseman]

Shhhhh!  Dollar cost averaging only works in a market that is appreciating over time.

[mark mchugh]

Bullshit flag:

The average mutual fund saw returns of about 7 percent.....

I'm not blaming the author, but don't believe that number.  It was probably extrapolated only from funds that survived twenty years (many don't - remember all those internet funds?).

I don't know if it's truly possible to calculate the average returns of equity mutual funds (that's what I think the author meant), with the data available.

You can however calculate an average return of ALL mutual funds using data from the ICI.  It's less than 3.3% for the last 20 years.

[FreeElectron]

What we call "luck" is far more mysterious than we can grasp.  I play a lot of no-limit poker; I can recognize skill, I can occasionally identify cheating, but my mind's grasp on reality is shaken when I witness a long series of cards come off the top of the deck (sometimes over a period of hours of continuous play) that in a wide variety of quirky ways consistently heaps good fortune on just one of the nine players at the table, to the detriment of all other players.  The math wizzards, who can quote odds at any point in the play to the tenth of a percent and believe they understand probability, get crushed.   Did this player learn how to manipulate "luck"?  Is there a poker choreographer behind an invisible curtain (other players often reap much delight from the string of non-repeating oddities, even as their bankrolls dwindle, hinting at a possible script of some sort)?  Afterward, other players will dismiss what they have witnessed with terms such as "on a rush", "running good" or "lucky".   Weak and superficial terms, meant to quell the spinning mind and bring us back to the comfort of what we call "reality", having just been a part of something profound and inexplicable, for which the math wizzards will then calculate odds in terms of multiple lifetimes.  I have no explanation based on rational thinking.  I refuse to slide into superstition, but I feel the gravity-like pull.

[Privatus]

Whichever one you believe matters, matters.