The role of luck in investing.

How to understand Wall Street.
Sept. 13 2004 2:58 PM

Smart? Skillful? Probably Just Lucky

The (vast and unappreciated) role of luck in investing.

Read Henry Blodget's detailed disclosure statement here. To read previous installments in the Complete Guide to Wall Street Self-Defense, click here.

(Continued from Page 1)

This is not to say that all investing success is luck—it isn't. Some people are better than average, and, over time, some of them will generate superior returns. (According to John Bogle's Common Sense on Mutual Funds, approximately one in six mutual fund managers has enough skill to consistently beat the market after costs—1 in 6.) This skill, however, has little to do with the simplistic price predictions that dominate most market discourse. It stems from discipline, patience, experience, and methodologies that lead to a rare ability to determine when the odds are distinctly good or bad. Skilled investors aren't immune from losses—far from it. They are just talented enough that eventually, gradually, their skill allows them to win.

The consolation is that, if your time horizon is long enough, investing an appropriate percentage of your portfolio in stocks is smart. Unlike flying to Vegas or predicting coin flips, it is playing the odds.(As described here, over most 30-year periods, stocks have performed better than any other asset class.) Concluding that you or your favorite strategist/analyst/broker/friend/fund manager is "skilled" on the basis of a few good picks or years, however, isn't. It's very common, though. If you do it, you'll have plenty of company.


Next week: If there is so much luck involved in playing the market, what are stock analysts for?


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