Healing Space | Is a great catch just dumb luck, in sports and in investing?

In the world of investing, with some experience you realize there is an order to the chaos, a skill to the luck. (Illustration by Suneesh K)

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Surely, every game in sports is a game of luck, right? It begins with the coin toss itself, which is anybody’s guess. Prior to that luck influences if a player has form, is fit to play, whether it’s a rainy day, and whether the opposing team is just having a rotten day and game. Rajasthan Royals may have gotten off to a great start, but what determines whether their benign beginning sustains?

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Michael Mauboussin, Chief Investment Strategist at Legg Mason Capital and author of The Success Equation: Untangling Skill and Luck in Business, Sports and Investing, believes luck and skill intertwine in specific ways in our everyday lives. If skill is the knowledge you bring to the practice or work, luck is reliant entirely on external influencing factors and has the quality that it could just as easily have gone another way. This sitting-on-the-edge quality of luck is what makes it equally capable of being good luck or bad luck. So, 10 runs is a really unlucky margin to lose by, but winning by 10 runs is a really lucky margin to win by for the opposing team.

Luck feels random, as though it is completely out of our control, and we’re either blessed or cursed. A traditional Indian view is that to win anything, we need three factors to be in play: prayatna, kaal, daivam, i.e. effort, time and the grace of god, or in modern agnostic terms, luck.

Does the same principle translate to investing as it does to sports?

Sometimes the stocks we pick after carefully doing our research just sit there like rocks, safe, but uninspiring. And at times the reckless gamble skyrockets. None of these happen to a formula and it’s often impossible to replicate it or teach others to do what has just happened. We exit assuming that fate or the gods were kind to us today. But in the world of investing, with some experience, you realize there is an order to the chaos, a skill to the luck. As Nikhil Kamath of Zerodha once put it, a mathematical precision to the undulations. The maths of variables allows us to impose some order or see the patterns in the seeming disorder. Mauboussin equates observed outcome to skill + luck. What this means is a test will see how much you know, but whether the portion you studied is in the test or out of it is up to the teacher, it is your luck. Similarly, sometimes a Test match will play to the player’s strengths, at other times a match will play to the player’s weaknesses. And here’s the thing, we each have plenty of both.

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Mauboussin explains how when luck contributes to outcome observed, we revert to the mean. In an interview with Wired magazine, he points out: “Over the last 20 years through 2011, for instance, the S&P 500 has returned about 8 percent annually, the average mutual fund about 6 to 7 percent (fees and other costs represent the difference), but the average investor has earned less than 5 percent. At first blush it seems hard to see how investors can do worse than the funds they invest in. The insight is that investors tend to buy after the market has gone up — ignoring reversion to the mean — and sell after the market has gone down — again, ignoring reversion to the mean. The practice of buying high and selling low is what drives the dollar-weighted returns to be less than the average returns. This pattern is so well documented that academics call it the 'dumb money effect'."

When we are too quick to attribute causes to results, we create a feedback fallacy. We link our effort to result, ignoring multiple influencing factors and the reversion to mean in the interim. So, if we’ve worked really hard at researching a stock that doesn’t really give us returns in the end, but find that our gamble got us great wins, we tend to link the result to the effort, and claim that more effort weighs us down, but intuitive risks help us win big. When the next risk fails, we blame luck.

Psychologically, however, luck and intuition are more likely to be the mind operating at a rapid pace and making connections based on apriori knowledge. You took that chance at a six because you quickly assessed and calculated the gaps in the field. However, you may have missed that on the last time you took that risk, Deepak Hooda had overeaten at lunch and wasn’t as agile since he was feeling very sleepy. He didn’t like the sabzi this time so was quick on his feet. And thus, the batsman’s ill luck has little to do with it. It’s more a factor of causes and conditions that sit slightly beyond the field of perception and that we are able to make valid connections about or not, based on our experience with our skill. Drawing those valid inferences is what enhances the luck factor.

As Samuel Goldwyn said, the more skilled I am, the luckier I get.

Questions to ask yourself to get luckier

1. Clarity of perception: look for all influencing factors.

2. Clarity of distortion: what is disrupting the view?

3. Factor the unknowns: what is it you don’t know?

4. Factor the blindside: what is just around the corner?

5. Balance the play: Is it testing your strength or weakness?