Investing - Game of Chance or Skill?
Huge volumes are written about investing and stock picking so my aim in this article is not to write an essay and be preachy, but just to give you something to think about when you investing and show you that lady luck actually plays enormous role even when professionals are playing with money. Especially your money.
Money Managers
Money Manager is a person that is in charge of buying and selling securities with other people’s money. Their client’s money that is. Money Manager can have hundreds of clients with each bringing more than million bucks. Sometimes combined poll of money can be in billions. Money managers invest that money or portion of that money to sell and buy stocks and other securities as they see fit. It’s in their interest to get a big return on investment since they’re usually take a cut in percentage of the total sum, or even have up front fees. We also all know that there’s some money managers out there that are really successful and have 5, 6 or more years winning streaks, but sooner or later (probably sooner) that winning streak will end, and money manager will start performing mediocre or even very poorly.
They will use best technology and information money can buy, but that will not help them. It’s like a clockwork. Check it out if you like. So what’s going on here? How come money manager who constantly made money 5 years in a row suddenly started performing so poorly? Did he get less skilled as years goes by? Or could it be that all those years he was more lucky than he wanted to admit? But how can it be luck, winning that many years in a row? It’s seems like a paradox. Here’s how it can be done just by chance alone.
Making ordinary people into market gurus
Let’s take a pool of 1,000,000 people (one million) that have no idea on how to invest money. Let alone manage someone else’s money. Those are going to be regular, hard working people with no interest in stocks or securities. Give them each certain sum of money to invest by picking stocks and securities they like for period of 12 months. After 12 months each will have to report their losses or earnings.
What do you think will happen here? You might think that they’re all destined to go broke within few months, but that will not happen. Statistical chance alone dictates that at least 10% (100,000 people) will just get lucky and make money regardless of their skills and experience.
Sure, probably 90% will fail and go broke before year is over, but those lucky 10% WILL make money just by pure luck. Remember: they had no skills or any knowledge of anything related to financial markets. Intuition might play some minor role here but it will be very small. That alone will not make them successful money managers who make profits year after year you might say. Well, we’re not done yet.
10% out of 1,000,000 people is 100,000.
Let’s take remaining 100,000 winners and have them invest for a second year. Again, just by pure luck 10% of those remaining 100,000 people will become successful.
10% out of 100,000 is 10,000. So right now we have 10,000 people that had success two years in a row already.
If you take remaining 10,000 winners and let them invest for a third year then you would have 1,000 successful money managers for three years in a row! 100 successful money manager 4th year in a row and 10 really successful money manager for 5 years in a row. All of them armatures that never seen threshold of financial college.
And that’s how it can be done.
I am not saying that’s how’s done in a real word, but I think that luck plays a way bigger role than people are ready to accept. It’s not easy to detect if your stock picking is just luck or skill, but remember following quote:
“Don’t ever mistake bull market for a skillâ€
That means that everyone is lucky while investing while markets are going up. It’s not a skill, you just investing at the right time. True skills are seen in bear and stormy markets (like the one we’re in right now at the time of this writing). Just ask any of your friends if they’re making money in todays market or on their 401k plans. By the way 401k plans ARE managed by professional Money managers. To me, it is more important to look at the money manager’s performance during his/hers career then actual fund performance. There’s always a bull market somewhere and you’re depending on a money manager to find it.