Does Luck Matter in Investing?

About a week ago, I blogged about within the financial markets, how many investors are truly skilled investors. We talked about how luck plays an integral part in our investing journey, argued that it is very important for investors to have a good concept of the importance of luck and approach investments in a probabilistic manner

Simply put, the better the odds are, the more you should be investing on it.

If you are foreign to the above concept, we strongly urge you to have a glance at the previous article before diving head in into this article, where we discuss whether luck matters in investing.

Role of luck in great returns – time horizon

We believe that there is indeed greater luck involved in the short run compared to the long run. Just imagine that you were speculating in the forex market by attempting to predict the Brexit results. Unless you had an information edge over the public, you probably would never have gotten it right since the media had been giving the public inaccurate signals the entire time.

However, if you managed to predict it purely by logical reasoning, how much would you attribute that judgement to your own skill? It is more likely that lady luck was on your side than it was due to your hard work trying to analyze and pry into the hearts of millions of people.

It is obvious that it is much more difficult to flip a coin and get head 90 out of 100 times than 9 out of 10 times. The larger the sample size or the longer the time horizon, the less likely that results are attributed to luck. Great investors and businessmen like Bill Gates, Warren Buffett and Jack Ma didn’t get to where they are and remain there purely because of luck. It takes considerable effort, insight and intelligence to be at where they are.

“How do great value investors tame luck? What are they doing that we aren’t?”

Stocks are businesses, not pieces of paper

When most people think of the financial market, they either imagine a ticker going up and down rapidly or a colourful bar chart. The stock market gives off a very misleading impression that it is a haven for speculation. If you submit to this ideology, there’s not a single chance that you will be able to control luck. You will find yourself at luck’s mercy.

However, if you begin to understand that holding stocks is equivalent to taking fractional interests of the business, your thinking will become way more advanced than the typical investor.

Would you sell your company just because it’s having a bad day? Would you buy a company when it gets more and more expensive?

Benjamin Graham, founder of value investing, famously said that investors should buy stocks like they buy groceries, not the way they would buy perfume.

The simple idea is to buy cheap and sell right.

Prepare for the worst, returns will take care of itself

While we have briefly covered this in the first article, we cannot help but re-emphasize the importance of being risk-averse.

While the entire financial market is going crazy about the next big thing (e.g. bitcoin), you should be extremely cautious. When the crowd is exuberant, it is most likely that irrationality is taking place.

In the 1970s, young companies with no credit began issuing out junk bonds to have a great head start in their businesses.

Investors were obsessed over the high yield and returns that they were giving and completely ignored the default risks that accompanied them. They probably hoped that the interests will cover the principal invested by the time the companies defaulted.

Needless to say, the fad died out and those who had their hands full of low-quality junk bonds wished they never knew about the market’s existence.

After hearing numerous stories about financial crises, we can bet that people will commit the same mistakes again. The greed to gain immediate profit and the irrational fear that the financial market will disappear overnight are two motivating factors behind why value investors will prevail. It is precisely because of the market’s inefficiency that we are able to generate so much profits over and over again.

Know when you’ve made a mistake

Humility is one underrated attribute that is essential for success. Very often, bright and talented individuals fail to progress due to their crippling ego. They believe that they are always right and others are wrong. Even when the market goes the wrong way for far too long, they are still adamant about standing by their views.

I believe you can name a few prominent investors that comes to mind.

So, are you one who is prone to having too much pride and ego or someone who can readily admit mistakes? If you belong to the former, you may find it difficult to answer this question.

Over time you will soon realize that luck plays a huge part in determining the environment. Sometimes it’s favorable sometimes it isn’t. Your ability to be successful in the financial market is not contingent on how lucky you are but rather, your reactions towards your circumstance.

Are you going to back off just because your portfolio suffers a 25% loss or will you keep a cool mind and reevaluate your holdings?

If you’ve lost consistently in the financial market, are you going to able to stomach your pride and admit that you were wrong?

The stock market exposes the weaknesses of individuals. It is a platform where strong emotions manifest itself. If you aren’t able to decouple yourself from irrationality, however much effort you put in, the financial market will consume you instead.

How do you prevent yourself from such influences?

We have good news for you! You are already taking the first and most important step to achieving that by taking the initiative to read about what it takes to be a value investor. This is one path that most turn a blind eye to because it commands too much self-discipline and hard work.

Want to find out more about value investing? We have talked at great length about different topics on risk, markets, psychology and many more! If you liked this article, we encourage you to read deeper through the free and readily available materials on this blog.