They all matter
There is a famous saying that it is better to be lucky than to be good. The underlying truth of this cliché comes from the fact that in the world of investing, luck and skill are difficult to distinguish from one another. The reason for this is due to the high degree of random fluctuations that impact the value of investments. This frequently results in “lucky idiots” and “unfortunate geniuses” who just happened to succeed or fail in a particular time period due to the simple impact of dumb luck. This leads some to the unfortunate conclusion that luck is all that matters, and that there is no point in attempting to acquire skill, since lucky morons can come by and outperform your highly informed, intelligently guided effort with nothing more than pure chance.
It is most certainly true that luck is an important part of investing, but luck is not the only part that matters. The downside to luck is that it happens to be random. This means that it can leave just as quickly as it came. Over time, luck tends to even out and skill becomes the key differentiating factor.
There are most certainly exceptions to this rule, since there are some people who manage to labor under extremely long streaks of both good and bad luck. Simple probability dictates that if enough investment managers are in the market, there will be some who have unbelievably long streaks of exceptional performance. (*cough* Warren Buffett *cough*) Of course, it should come as no surprise that we have never heard of investment managers who fail to beat the market for multiple decades, because they would have been fired long before they had a chance to build a long track record of failure. (Typically, politicians are the only ones able to stick around long enough to accomplish this feat)
The important aspect for us to consider in the conversation of luck and skill is the factor of patience. The reason why patience plays such an important role in our personal, professional, and financial lives is because it is the great equalizer.
Over time, people who jump ahead early because of luck will frequently fritter away the fruits of their good fortune in foolish decisions. They will become convinced that they possess such prowess that they are a shoe-in for success. They typically take bit risks, and are set up for a big fall when the tides of fortune do not move their way. When luck is no longer their ally, they frequently collapse.
Conversely, people who experience early difficulties, but persevere in building and applying exceptional skill in the face of consistent pressure frequently meet with long-term success. The reason for this is because they develop the habit of consistent perseverance and skilled effort. Thus, when the wheels of luck finally align in their favor, they are prepared to make the most of it.
It is important to understand that the most wise investment strategy is not always the one that generates the highest returns. Many people are seen making large amounts of money by taking large amounts of risk. This looks great until their wealth comes crashing down after luck turns against them. Conversely, the strategies undertaken by the wise don’t typically look that exciting since they seek to maximize their risk adjusted return, instead of their total return. This means that they typically take much less risk than some other investors, and will not hit the “home runs” that people hear about on the news, but they will also be more protected against the implosions that plague investors who are in eternal pursuit of quick money.
In our personal, professional, and financial lives, we must remain mindful of the impact that luck, skill, and patience have on our long-term success. Of these factors, skill and patience are completely within our control, and luck is completely outside of our control. By focusing our efforts on developing the most skill we can, and exercising prudent patience, we will place ourselves in an advantageous position to achieve long-term success.
Action Item: Focus your efforts on building skill and exercising patience. Learn to avoid the temptation to fall into the trap of chasing the quick buck from strategies that rely on luck.