Skill vs Luck
Legg Mason’s Michael Maubossin looks at the difficulties in untangling outcomes that are based on skill or luck or both as applied to the universe of investing.
His conclusions?
• The outcomes for most activities combine skill and luck.
• Separating skill and luck encourages better thinking about outcomes and
allows for sharply improved decision making.• There are good methods to sort skill and luck in sports, business, and
investing.• We define the key features of skill in the investment business.
This is going to be my train reading on the way home . . .
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Source:
Untangling Skill and Luck: How to Think About Outcomes—Past, Present, and Future
Fortuna, by Albrecht Dürer
Legg Mason, July 15, 2010
http://contenta.mkt1710.com/lp/26966/115068/Untangling%20Skill%20and%20Luck.pdf
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July 26th, 2010 at 1:41 pm
~William Bernstein
I’ve often thought that the only skill I need as a trader is the ability to recognize exit patterns instead of entry patterns. I figure entry is luck and exit is skill.
July 26th, 2010 at 1:44 pm
I think that I would really like to know what he thinks about his boss, Bill Miller.
I believe that his response to whether Bill was skillful or lucky would say a lot about his intellectual honesty.
I do not believe has made a public statement either way.
July 26th, 2010 at 1:53 pm
Fama and French posted a thorough statistical Luck vs Skill study last year and concluded that while some fund managers exhibit skill for some amount of time, the population exhibits no skill at all. If you take into account management fees, you are better off indexing.
So for the inactive investor, the luck/skill problem is not picking equities but picking fund managers.
July 26th, 2010 at 2:07 pm
Taking a quick look at that “Skill v. Luck” spectrum, I would say that we as a society need to totally rethink the way we tax “investing.” Since we have chosen to tax pure “luck” (gambling) sources of income as regular income and since “investing” appears to resemble gambling much more than other sources of income, why aren’t we taxing “investing” exactly the same way we tax any other source of income? Anything else is just welfare for the “investor” class.
July 26th, 2010 at 3:18 pm
Also remember – there are patterns in random data. Consider a scenario where you set up a machine to throw random darts at a count level map of the USA. Arter 2000 darts there will be some counties with zero darts and some counties with lots of darts.
If each dart represents 100 cases of (fill in disease – ie cancer, autism, asthma) – then find the counties with lots of darts and send in the lawyers to start looking for polluters …
July 26th, 2010 at 3:18 pm
I would disagree with putting baseball in front of footbal on the skill – luck spectrum. Baseball is heavily dependent on luck. Look at the playoffs. The team with the best regular season record rarely wins and in the NFL the Super Bowl is usually made up of the top teams.
July 26th, 2010 at 3:42 pm
of course skill and luck are important, but lately in securities trading the following factors have been more important than either skill or luck:
Theft
Fraud
Forgery
Front-running
Goldman Sachs
33 Liberty Street
being a “fly on the wall” in Bernanke’s office
being a “fly on the wall” in Geithner’s office
July 26th, 2010 at 4:15 pm
b_thunder Says:
July 26th, 2010 at 3:42 pm
of course skill and luck are important, but lately in securities trading the following factors have been more important than either skill or luck: …..
reply:
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10 out of 10 aka things I wish I said
July 26th, 2010 at 4:44 pm
“Skill v. Luck” ??
12 Games the NFL May Have Fixed in 2009
Read more: http://blogs.myspace.com/index.cfm?fuseaction=blog.view&friendId=413373319&blogId=526080054#ixzz0uobpx5Bx
?????
July 26th, 2010 at 5:23 pm
The author states “the outside view asks what happened when others were in a similar situation before…The outside view provides a better grounding for analysis.” THAT’s what you do, Mr. Ritholz. You bring (at least the perception of) an outside view in your blog. Turn the situation on its side and bottom and see if it looks like something else that we’ve seen before. Like gold at a breathless $1250 in 2010 or home equity that was being used as a big ATM machine in 2005. Keep it up, Barry. Thanks.
The longer the period for investing, the less that randomness (luck) is involved. Hmm.
2010 would seem to be the year for non-index large-cap dividend investing. Low interest rates, large companies that can withstand the foolish policies of the Executive branch of the Federal government, 15% max tax rate on div & cap gains, massive disruption in certain industries: media, advertising, real estate. Large cash stockpiles at S&P500 companies waiting for time for vulture investing. What a great time for large cap value investing! Thank you for the article.
July 26th, 2010 at 5:27 pm
If Skill is asymmetric information and a revolving door to regulators, lobbyists and lawmakers in the securities space, then Goldman does not need Luck to to win every day of the quarter.
July 26th, 2010 at 9:11 pm
NoKidding –
This is an extremely silly way to think about the “money management” problem set.
OF COURSE, the “total managed universe” has no skill net of fees. But what does the “top quartile” do? And is it persistent? Howabout the top decile?
I promise you the top 1% is extremely persistent and with knowledge one can select this quite easily and comfortably. But the AVERAGE investor will always get average. Thats just a tautology. Not a statement on skill (oh how Bill Sharpe rues the mis-interpretation of his work).
Silly use of “averages”.
July 28th, 2010 at 11:03 am
The key lessons here are to know how the “game” you are playing actually works. In this case, knowing how much something relies on skill vs. luck says a great deal about how much time and effort to put into learning it. Knowing where to best focus your energies and knowing what your limits are makes a huge difference in making the most of your limited resources. Bottom line: knowing why and how better positions you for sustained success than just “knowing” what and when.