Luck vs Skill - Can I Lose Money

Hi, this is Cameron Hight of Alpha Theory.

One of the common questions that we get from allocators is how do I figure out the skill of my manager?

One of the challenges of figuring out the skill of a manager is there's a lot of luck involved in investing.

Now, what do I mean by that?

A lot of what I'm going to explain here comes from the thoughts of Michael Mauboussin and his book Untangling Skill and Luck.

If we look at the content continuum of games, we have things like chess and tennis at one end where there's a lot of skill and very little luck, and roulette at the other end where there's zero skill and it's all luck.

Where does investing fall?

The closer you come to an all skill game, the easier it is to measure skill.

The closer you get to luck, the harder it is to measure the skill because it get it gets mixed up with the luck.

And so one of the thought experiments that Mauboussin uses in his book is imagine you had to lose the game.

Could you do it?

So, in chess and in tennis, yes, I can do things that affect my ability to lose the game.

I can lose the game.

In roulette, I couldn't lose no matter how hard I tried because it's 100% luck.

And so where does investing fall?

If I gave you $100, could you lose it?

The answer is maybe it's not that straightforward.

You can't lose the $100.

Imagine the stock that you really don't like is going to 0.

You put in the $100 and it gets acquired and it goes up 150%.

So, it's one of these things where there's so much.

There is skill, demonstrable skill, but it's very difficult to untangle that from the luck that surrounds investing.

It's one of the cool challenges of what we do, and if others have great ideas on how to measure skill and untangle that luck, would love to hear from you.

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