We all like to attribute our winners to our foresight and cunning. The losers? Well, they were the result of bad luck.
The truth, of course, is that random chance — both good and bad — plays a scarily big part in shaping our investment outcomes. That’s not to say it’s all just a roll of the proverbial dice, but it pays to face reality as it is. And the reality we inhabit is a chaotic maelstrom that makes stock investing an inherently hit & miss affair.
One solution is to lean into this hard truth; passive investing really only requires we assume society, on average, will get better over the long run, and that `the enterprises that help bring about a better future will create a good deal of value for their owners. Yes, a majority of companies will prove to be rather ordinary, but the way indices are constructed means you’re guaranteed to gain exposure to the winners, and their success will be such as to offset the laggards, and then some.
That, at least, is how things have played out so far.
While that is eminently sensible it is, let’s face it, rather boring. And the very fact you’ve elected to join our rag-tag band of investing tragics means you prefer the cut and thrust of stock picking. Partly because the return potential is better, but also, no doubt, because there is a great deal of intellectual satisfaction in finding and owning wonderful companies.
Given this predilection (arrogance?), how does one factor in the role of luck?
An important first step is simply to acknowledge it. Investing is one of those fields where you can do everything right, and still get a poor outcome (likewise, you can do really dumb things and get rewarded!). As such, you can’t really determine the merits of your approach based on just a small set of results. Your process must be evaluated over a lot of individual trades, and in different market environments.
As Peter Lynch said, if you’re good you can expect to be right roughly 60% of the time. And that’s more than enough to deliver outstanding long-term results — in the same way that playing with loaded dice will, eventually, ensure you come out ahead.
One thing to note here: be careful not to measure success or failure too early. Many of your best investments will likely have a shaky start — it’s the height of hubris to think that the second you take a position, the wider market will instantly re-rate things in your favour.
Have patience, grasshopper.
Accepting the role of luck should also encourage you to avoid making highly concentrated bets, regardless of how strong your conviction. There’s no such thing as a “sure thing”, and you always want to ensure that, should the unexpected happen, you live to fight another day.
Remember, there are old pilots and there are bold pilots, but there are no old, bold pilots.
Finally, and perhaps most important of all, you must do what you can to make your own luck. As Thomas Jefferson said “I find that the harder I work, the more luck I seem to have.” Or, as Seneca put it over 2000 years ago, “Luck is what happens when preparation meets opportunity.”
If you’re not prepared to put in the hours, lady luck won’t grace you with her presence.
May the odds be ever in your favor.
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