Are investors lucky, skillful, or both?

If you are reading this, you can probably consider yourself lucky.

It should be stated up front that this has little to do with the quality of the column before you. Rather, it’s because the fact of your reading it suggests you live in one of the wealthiest countries in the world, with spare capital to deploy. Stockpicking is, by proxy, a rich person's problem.

Warren Buffett, history’s most over-analysed investor, has never shied from highlighting the role of luck in his life. Not only has he regularly referred to his birth date and US citizenship as the equivalent of a winning lottery ticket, but he even puts part of his enormous investing success down to fortune. “In some cases,” he wrote in 2022, “bad moves by me have been rescued by very large doses of luck.”

Such grounded humility offers reassurance. After all, if our own investing career falls short of Buffett’s, then it might be due to a force beyond our control. Joachim Klement, an investment strategist at Liberum, even argues that a positive correlation between extremely successful investing and increasingly large dollops of luck is “just a matter of math”.

Others view luck as critical to outperformance. Given that investors tend to be good at incorporating new information into stock prices, and the fact that investors' skill has become more uniform across the market, the quantitative analyst Michael Mauboussin has suggested that excess returns increasingly tend to be the product of luck.

Despite this, a recognition of the role luck plays doesn’t (and will never) arrest our preoccupation with the extreme tail-end of performance distribution – where returns eclipse those of nearly everyone else – or our attempts to unpick the genius behind the world’s best fund managers, investors and businesspeople.

This is also sensible. Because investing isn’t a random process, it is only logical that we should want to understand the role skill can play. How then, should we make sense of luck and skill in our own investment process?

To try and answer this question, I asked my colleagues to look at the pieces they had written for our investment ideas section in 2022, and then assign each idea one of four scores – the product of good analysis, good luck, bad luck, or bad analysis – based on the subsequent performance. I left it to the writers to decide what success looked like, though it was usually determined by index outperformance.

The results showed that writers were more likely to attribute skill, or lack thereof, as the deciding factor, regardless of performance – though this tendency was more pronounced for ideas which just beat the index, and the worst-performing ideas. But paradoxically, writers were more likely to place greater weight on the role of luck when it came to the very best performers.

Indeed, the balance is full of paradox. If it’s possible to make an investment that succeeds for reasons other than your skill (i.e. through luck), then can a failed investment ever be said to be based on sound analysis? At an individual level, any hunch that you got lucky is a challenge to your sense of agency and skill. And yet if a well thought-through investment pays off, it won’t (and shouldn’t) feel totally random.

One reason why investors find it hard to disentangle skill from luck has to do with time. In Fooled By Randomness, the polymath Nassim Nicholas Taleb argues that because short-term market movements are noisy and unpredictable, skill can only be reliably observed over longer stretches of time.

Luck is real. Real life means variability. But showing up, staying invested and staying patient have a huge bearing on investing returns, too. Fortunately, these are also qualities that you have more control over, regardless of your stockpicking abilities. With some sensible precautions and understanding of risk, investing is a discipline in which making your own luck is a skill anyone can learn.