• Editor's Note
  • Editor's Note

    by Charles Rotblut, CFA

    This month’s issue features a discussion about how to differentiate between luck and skill. It is a topic Michael Mauboussin of Credit Suisse covered in his book “The Success Equation” (Harvard Business Review Press, 2012). When we spoke, Michael opined that skill plays a role if you can affect the outcome. A transcript of our conversation starts here.

    Michael thinks investing falls pretty far over to the luck side of the luck-skill continuum. I agree that there is a great deal of luck involved, since we investors have no control over the economy, the management decisions made by the companies we invest in, earnings, analyst ratings, what fund managers do or how all other investors and traders act. Much of what moves prices is the reaction to and the anticipation of new information. This is why some experts, such as the economist Burton Malkiel, say the movement of stocks is a “random walk.”

    On the other hand, there are steps I think an investor can do to maximize his return given the level of risk he is willing to tolerate. Learning how to analyze securities and funds, diversifying, adhering to what has worked well over the long term and avoiding behavioral errors will lead to comparatively better outcomes. By focusing on these things, an investor can create “luck” for his portfolio.

    Part of my view toward creating luck comes from playing poker. Though admittedly not a perfect analogy, poker is a game of statistical probabilities where skill can have a small but measurable impact. A player who focuses on playing good hands (e.g., a pair of aces) and quickly folding bad hands (e.g., a three and an eight card of different suits) should win more often than a player who ignores the odds. Process, in both poker and investing, is important.

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    Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/CharlesRAAII.


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