Amongst the best writing on investing are two books: ‘The Black Swan’ and ‘Fooled by Randomness’ written by Nassim Nicholas Taleb. These are not without their detractors but essentially they describe the very high element that luck and chance play in determining investment returns. Most importantly they are persuasive in explaining how success is often achieved by sheer good fortune.
Many commentators recognise the importance of luck – the simple fact that if you have enough players in the markets then by virtue of straightforward chance some will succeed.
The best way of thinking of this is to imagine 100 people walking into a casino each with £100. They are all tasked with playing roulette backing red or black and playing for an hour. They can back red or black on any spin of the wheel as they choose and bet any sum of money they like.
Typically, within one hour, there would be around 30 separate spins of the roulette wheel. On an average spin somewhere between 48 and 49 of the players will win, selecting the right colour.
Over the course of the 30 spins, or the hour, there will be a handful of players who will hit a lucky run, backing the right colour more often than not and getting their management of the money, the stakes they place on each spin, more right than wrong.
After an hour there should be some players who have turned their £100 stakes into £200 or maybe more, possibly much more. Most of the players will have lost money, some will have lost the lot. On the average, players will have less than £100 each.
Now parlay this situation into the markets; have the players who did well actually played better? It is true they may have managed their stakes better (working out an efficient way of maximising their return or minimising their risk) but otherwise they will simply have been luckier. Roulette is a game of chance and so it is with investment markets. It is entirely possible (in fact, probable) that with sufficient number of players (investors, fund managers, speculators et al) some will strike it lucky.
This is further enhanced by a phenomenon called survivorship bias whereby those who do well survive and those who do not disappear. This means that we tend to see those that have survived through this bias and don’t see those that don’t!
In this way, when we view markets historically the ones that have survived (probably including the luckier ones) become the focus and the ones that do very well, even spectacularly so become the focus of articles and features, they write books and go on lecture tours. They become the influencers. Their views, methods and so called skills suggesting they have something magical for others to tap into and follow.
Anyone looking to master financial planning, to create and preserve wealth should be aware of how prevalent this phenomenon may actually be. In this respect past performance of a star investor or fund manager really is no guide to future returns. Simply because their luck may run out at any time.
Our book – The Wealth – explains the eight basic principles that need to be applied by any individual seeking to create long term wealth for themselves and their family. To read more about the book click here: https://www.penguinwealth.com/wealth-secret/
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