FOOL'S EYE VIEW
Luck or Skill?

By Stephen Bland (TMFPyad)
February 5, 2001

Debates sometimes occur as to whether long term investment success is due to luck or skill.

Anybody who decides to read about equity investment will discover that there is a huge number of books out there, mostly American, of varying quality. A lot of them focus on the investment lives of individuals who are known to have been successful over a long period. Many, but not all, of them are written by the people themselves.

The names are well known. All styles can be found among successful investors and almost any approach that can be defined will probably somewhere have a book about someone who has made a success of it.  Some of these famous investors perhaps qualify for the overused epithet "legendary". Buffett certainly does, I would say.

One paradox that has always troubled me about such guys is that the general investing public seems to find it impossible to emulate their success. How many Buffetts, Lynches and Slaters are there? I don't know the answer to my own rhetoric but logic suggests precious few. The stock markets are probably not littered with billionaires or even millionaires among private investors.

Yet in theory shouldn't it be simple? I know absolutely nothing about Warren Buffett, for example, his style does not interest me, but why cannot an investor pick up a couple of books about how he does it then repeat his success? Or of anyone else who has achieved great success and whose technique can in theory be gleaned out of a book for a few quid?

The answer to my mind is that you cannot bottle great investment skill and market it to people desperate to learn and emulate. Because the missing ingredient, the unmarketable bit, is the person's mind. The way he looks at a potential share purchase. With people like this their true approach is never merely some quantifiable set of data that determine a great share, the analysis of which can be simply spelled out like a recipe in a cookbook. What cannot be easily conveyed to readers is the exact way the guy looks at a share. Perhaps the person does not actually know themselves, not in words or figures anyway. I believe that such investors possess an instinct and I doubt you can learn instinct.

Back to my title theme. If someone makes money repeatedly out of an investment style is it luck or skill? Most will know the pop statistically possible theory that if you start with a large enough group of people investing and see if they can beat the market each year, then simply by luck after some years there may be some players left in the game who have won each year. In other words proponents of this concept are saying that you cannot determine even with repeated success whether this was ultimately due to luck or skill. I am not sure whether I buy this idea or not but I tend strongly towards not, with just a pinch of doubt.

It strikes me as related vaguely to that other pop statistical theory that if you get enough monkeys typing for long enough you will wind up with the works of Shakespeare. In practice you never would of course, or as close to "never" as makes no difference to the practically zero odds of this happening if you want the true answer.

Similarly, is it really likely that repeated investment success over many years owes that success to blind luck? I think not. It is not likely. It is possible, anything is possible, but it is not likely. And investment is about likelihoods, never certainties.

So in general I believe that the success of the great investors whose success has been publicised by their books does result from their personal skills. But can you learn from the books how to be them or even come within a fraction of their success? For example, Warren Buffett may be a billionaire but I am sure most small investors would be happy with making a mere million in the markets. Yet how many ever will? Almost none, is my guess.

Some years ago I read a few of these personal investment style books myself and it all sounds so simple. Yet my belief that you cannot become a great investor by reading about another great investor and following what is stated there was always at the back of my mind. Ingredient X is just not in the book.

So yes, great investment is almost certainly skill, not luck in my opinion. But can you learn that by reading about some else's skill at it? In the great majority of cases, "no" has to be the answer, regrettable though it is.

One explanation may be that a person should invest only with their financial personality. Those attempting a style they have read about and who are blinded by its success, will right away be turning the odds against them if they are not suited to it. No point in being a long term hold investor if you know you will be constantly troubled by the fluctuations and are likely to be panicked into selling as soon as some bad press report spooks you, for example.

Another explanation is risk attitude. Making a lot of money in the market will likely involve more risk than most small investors are willing to take. What characterises many greats is often their willingness to take large risks by investing a lot in a very few shares, maybe only one in the early days.

There is still ingredient X, though.

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