Luck vs Skill in Investing
In most arenas, the role of luck and skill becomes quite clear in a short period of time. Not so in investing. So-called investors can ride their luck for some time, while real investors can rue their luck and question their skills for years. Especially when the number of stock picks involved is small and the time period is short.
“In the short-term, the market is a polling machine. In the long-term, it becomes a weighing machine”
Anyone can pick a random stock, and just by statistical luck, make gains for some time. This is the law of small numbers. However, once you start to repeat the process, statistics will not help you. Repeat investment gains do not happen by luck, and the number of times you repeat, the lesser the role of luck. As you increase the number of instances of stock-selection, AND lengthen the duration of the investment, choices made based on fundamentals of the underlying company and the valuation start to affect the results.
This is why you will see even many professional funds beat the S&P 500 by large margins one year, and nowhere to be found in subsequent years. It is the rare stock-picker (individual or professional) who succeeds in the long term (10 years and beyond). Some data shows that barely 2% of investors beat the market averages after 10 years. The longer this time, the more the chances that the investor is skilled and not just lucky.
Unfortunately, most “investors” chase the hot performers. Funds that beat the market in one year attract billions of dollars in the next, and then promptly lag the market. Past performance truly is not a good indicator of future expectations, UNLESS the performance is consistent over long time-periods, like that of Warren Buffet and Charlie Munger at Berkshire (and many others described in our blog article on “SuperInvestors” here…).
The only way you can evaluate an investor is to understand their underlying process, the reason for buying and selling a stock. That is what works long-term. If the reasons are valid, good performance follows and vice-versa. Fortune-telling does not work. Super-forecasting does, if it is based on vast experience and reasonable assumptions.