Are You a Skillful Investor or Just Plain Lucky?

By Kainoa Blaisdell

The question of luck versus skill is one that comes up quite regularly in investing. Interesting enough is that it is harder to tell the difference than one might think. It is not unusual for some investors to claim that the stock picks that have done well in their portfolios are down to skillful share selection. They will crow about their success to anyone and everyone. And, yet, in the same breath, they will assert that the ones that have not done so well – or have crashed – are the result of bad luck.

If you think about it logically, both statements cannot possibly be true at the same time. It is not possible to attribute stock picks that have done well to your skill as an investor but blame the ones that have not performed well to bad luck. So, which is it to be? We are victims of a few psychological fallacies as human beings leading us to the blind acceptance of overconfidence. We have a tendency to make decisions on “observable” success, while ignoring “unobserved” failure – this is called the survivorship bias.

Lotteries exploit the survivorship bias to rake in billions of dollars, as do the great “Investment Gurus”. Lottery ticket buyers are motivated by the stories of the few jackpot winners who become instant millionaires however, the millions of ticket buyers who never win receive zero attention.

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What is the root of successful investing?

Do we need to be truly skillful or do we need to be very lucky to succeed in investing? And how can we tell, if only for the sake of our own peace of mind and our egos, if our success has been due to luck or skill?

One good way to decide is to be totally honest with ourselves and determine if our stock selections are based on a strategy or a testable trade hypothesis (idea). This is not just any old strategy, I should add.

Instead, it should be a coherent and logical strategy that can be shared openly and explained with confidence to other investors. If the strategy involves a list of stocks, a blindfold and a set of darts, then I think we can safely say that skill has had very little to do with selecting the stocks. So ask yourself if your own strategy is communicable and reproducible in its methodology for picking a stock.

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If you are able to communicate and articulate an intelligible strategy and replicate the approach time and again, then it is very likely that skill has played an important part in your choosing your stocks. That being the case the next question is whether or not it works… and can it continue.

A lucky investor could perform well simply because the economy is performing well too. And in so doing, the investor might believe that the success is due to skill, when in fact it is merely because he or she was in the right place at the right time. Others observing his outcome will also be compelled to follow this “genius”. But beyond a short timescale, luck for the lucky investor could quickly run out. In fact, the longer that you can outperform the market, the more likely you can attribute your success to skill. This is because it’s so easy to confuse luck with genius.

Based on our belief in markets being largely efficient and thus mean reverting, NEBA doesn’t call the markets or pick stocks for our clients, we choose to manage the movements of the markets with an expected return. Do we have investments that go bad? Of course we do. Do we have favourite investment types? Of course we do. It is how we manage the bad investments and monitor performance with you that makes us superior for long-term value creation.

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So overall, those clients who put their trust in us, make money. The point is to provide you with all the information you need to understand what is important to manage your risks in line with your expectations, while creating an investment structure that has clearly defined characteristics.

Although the majority of our investments are for cautious investors, NEBA sees nothing wrong with more adventurous or aggressive investments. There are many people who want these types of opportunities as part of their portfolio due to their own risk tolerance and return objectives. But we do like to inform our participants details that will help them decide if a particular opportunity is right for them and meet their objectives.

We want our bespoke and menu offerings to fit the users in every way possible. We prefer to have clients participate in investments that they want and need, this requires informing investors on exactly what they are getting themselves into.

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So, make sure you check the volatility rating of each Underlying Asset on our NEBA Factsheets to ensure your clients are purchasing a suitable investment for them. If you are in doubt or require more information on particular products and underlyings, feel free to ask one of our representatives and we’ll be happy to help you out as much as possible.

If you have clients that currently have Stocks or would like to invest in Stocks, NEBA can wrap the Stock selection in a structured vehicle to build in defensive barriers to protect downside movement whilst preserving upside potential. This can all be done with many actively or passively managed Funds and ETF’s as well so you don’t need to expose yourself 100% to a particular strategy or trade idea. Effective investment managers manage their risk and return through NEBA by customising portfolios with us.

One thing we have been seeing a lot of lately is the choice of products with monthly obsevation frequency. Many think this is a cautious investment due to the higher chances of receiving coupons compared to quarterly or semi-annual observation. These are anything but “Cautious” so you are probably better off choosing investments with darts if you think this way!

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