Luck vs. Skill

Comments posted to “The Role of Luck and Skill in Investing,” an interview with Michael Mauboussin, in the September 2013 AAII Journal.

I’ve struggled with how much of the returns in my system are “luck” and how much are “skill.” Only the most egocentric would assign a lot of skill, and those folks are riding for a fall.

That said, I chair a group system, called TtP-S, which deals with very high quality dividend-paying stocks in a blended investing and trading model. It follows a set of tight rules. I found myself assessing the relevance of Mr. Mauboussin’s theories as compared to our own investing system, and lots of spotlights (and a few alarm bells) went on. Also, we cover a bunch of his principles pretty well too.

I’ve pointed my group to this article and offered an investment book as a prize for the best posted analysis relating this article to what we do.

Thanks for an excellent article! Luck? Skill? Mean reversion? Good stuff.

—Peter Asprey from California

I enjoyed this thought-provoking article. But I disagree with the last statement, in which Mauboussin states that having success on one’s first investment is a detriment to learning which factors are important to increase the possibility of a good outcome.

I was part of a team developing a new chemical process. Our first experiment was a partial, if not perfect, success; and then we had six failures in a row. It is true that you can learn more from your failures than your successes. But without that first success, we might have given up on believing that it could be done. We just had to figure out what parameters were right in the first experiment that weren’t right in the next six attempts.

Similarly, in the world of investing if you have to start with six losses in a row, it might make you think a lot about what went wrong or it just might make you place all your investable money in a savings account and never invest again. Whether it is skill or luck, a little encouragement is not a bad thing. There will be plenty of learning opportunities for skill development, if one examines the losing investments against the insights of other investors, analyzes what appears to have gone awry and searches out what actions appear to have contributed to success. Yes, luck confuses the process, but experience can sharpen our understanding of what increases the probability of success.

—Charles Foxx from New Mexico

Growth at a Reasonable Price Is No Myth

Comment posted to “Debunking Stock Investing Myths,” by Charles Rotblut, CFA, in the September 2013 AAII Journal.

I have found that a “growth at a reasonable price” strategy both lowers risk (by bailing from or not selecting way above average price-earnings ratio stocks in the first place), enhances returns and generally leads one to emphasize mid caps (at a greater allocation to this area than total market weights) over the long term. Academic research, the performance of the AAII Stock Investor Pro screens, and my own 20-plus years of performance all validate this.

Likewise, pursuit of high dividends from slow or no growth companies is a proven loser’s game. Better to target companies with growing earnings and dividends, even if the dividends are modest.

—Michael Skinner from California

Correlations’ Role in Diversification

Comment posted to “Diversification’s Role as a Risk-Reduction Tool,” an interview with Richard Bernstein, in the September 2013 AAII Journal.

I read the interview with Richard Bernstein and thought it was quite good for the most part. However, I felt the article fell short on two issues:

It failed to point out the fact that correlations across asset classes tend to increase in declining markets, which makes diversification harder to accomplish.

It also tended to ignore correlations of the S&P 500 index with alternative investment vehicles (e.g., managed futures, long/short strategies, real estate), which in many cases show lower correlations and therefore provide greater diversification benefits.

—Steve Daniels from Connecticut