.svg)
Could You Lose on Purpose? Investing Luck vs. Skill
In this article, Cameron Hight discusses the “Success Equation” by Michael Mauboussin where he asks the question, “Could you purposefully lose money investing in stocks?”
I have some “go-to” thought experiments I pull out when speaking to portfolio managers and analysts. One is from the “Success Equation” by Michael Mauboussin where he asks the question, “Could you purposefully lose money investing in stocks?” (Read more about our Book Club with Mauboussin here).
Mauboussin suggests that stock investing is more akin to a game of luck, like roulette or craps, rather than a game of skill, like chess or basketball. This analogy raises an important question: Is investing more skill or luck?
The average batting average for long positions (percentage of investments that go up more than the market) of Alpha Theory managers over the past 11 years is 51%. This is better than random, but not by much. Said another way, you could possibly lose on purpose in aggregate, but you couldn’t on any individual bet.
Interestingly, there is a place where we can find more skill. If we look at all the long positions with forecasted positive returns, the batting average soars to 58%. This basically means eliminating all of the positions where the manager didn’t take the time to come up with price targets or where the expected return forecast has turned negative.
The data suggests there is real forecasting skill. This means that investing is not luck, like roulette. But it is not like chess either. It is a profession with a large dose of skill and luck, like poker.
In poker, the high-skilled player will almost certainly beat the low-skilled player if playing 1000s of hands. If playing 10s of hands, the low-skilled player can beat the high-skilled player. By contrast, the high-skilled chess player will win almost every game (if not every game).
What does this mean to you as an investor? Let your skill manifest itself by building an environment where you can be like the high-skilled poker player who gets to play 100s or 1000s of hands (investments) over a long period of time. Protect downside. Isolate skill by neutralizing non-skill factors (market and factor exposures). Try and find LPs that will stick with you long enough to let your skill overcome luck. And, if you can, get a little lucky. 😊
