The September 2013 issue of the American Association of Individual Investors (AAII) Journal carries an interesting interview with Michael Mauboussin on the role of skill and luck when it comes to investing. Here are a few salient points I extracted from the interview.
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- “There is actually a very interesting test to determine if there is any skill in an activity, and that is to ask if you can lose on purpose. If you can lose on purpose, then there is some sort of skill. Investing is very interesting because it is difficult to build a portfolio that does a lot better than the benchmark. But it is also actually very hard, given the parameters, to build a portfolio that does a lot worse than the benchmark. What that tells you is that investing is pretty far over to the luck side of the continuum.”
- “…investing is a difficult task. If you’re not inclined to do a lot of work on individual stocks or don’t think you have a high probability of having some sort of edge, that’s where the classic advice to buy mutual funds or index funds that are properly diversified may be your best bet.”
- “I think all of the research on success is actually fundamentally quite flawed. It turns out that there have been some researchers who have analyzed the studies quite carefully, and what they’ve found is that if you take the top, say, dozen studies of successful companies, they can only confidently code about 10% to 15% of the companies mentioned as truly skillful. The rest are there by luck. Even in corporate performance, there is an enormous amount of luck. That said, as an investor, the key thing to differentiate or think about is distinguishing between the fundamentals of the business and the expectations built into the price.”
- “It is very difficult to envision a scenario where for the next 20 or 30 years bonds do extraordinarily well.”
- “The expected return for the equity market is typically a combination of the risk-free rate, which is usually the 10-year U.S. Treasury note yield, plus an equity risk premium. So, with the 10-year note at about 2.25% today [early June 2013], and the equity premium by some reckonings about 5.5%, let’s call that 7.75% for the expected return of the market. I like to look at that equity risk premium, and especially the ratio of the expected risk premium to the risk-free rate. And that’s actually at very high levels, vis-a-vis history. So that tells you that equities are relatively attractive compared to bonds.”
If you happen to be a AAII Journal subscriber, I highly recommend reading this article.