People who are extremely successful in business or investing tend to see themselves as more skilled and hardworking than the average person. Undoubtedly, they are on a certain level, but the more extreme their success, the more luck plays a significant role in its achievement. Luck is so essential to extreme success, in fact, that those who achieve it do so almost entirely through luck. No offense intended for all readers, it’s just a matter of math.
Let me explain.
We are all captivated by the most successful people in the world. Jeff Bezos and Bill Gates are inspirations to many aspiring business leaders, and Elon Musk became a rock star through both his huge business accomplishments and his personal antics. In the investment world, we admire all-time legends like Warren Buffett as well as star fund managers with a string of strong returns like Cathie Wood in 2020.
We all know that a combination of luck and skill determines the performance of investors and business leaders. But what we don’t realize is that while luck plays a minor role in general, it dominates at the extreme ends of the distribution.
To see how it works, I simulated the performance of 10,000 investors, with their skill randomly distributed between 0% and 100%. At the same time, these investors had varying degrees of luck, with this attribute also randomly distributed between 0% and 100%. Overall, total success in this model is 95% skill and only 5% luck.
If luck plays such a minor role in success, becoming a top investor should mostly be a matter of skill. But this is not the case. The graph below illustrates the average luck score of our 10,000 investors as their performance progresses from average to increasingly successful.
Average chance of investors as their performance improves, when chance = 5% of performance
Of course, the average chance for all investors is 50%. Those in the top quartile or top 10% tend to be a little luckier than average. But investors who end up in the top 1% or 0.1% are extremely lucky. Even though luck only plays a 5% role in determining success, to end up in the top 1% or the top 0.1%, investors really have to be very lucky.
It also implies that the common approach of emulating the most successful investors or business leaders likely means following less qualified people.
The following graph reverses the process and explores the likelihood that the top 25% actually possess the top 25%. Among first-quartile investors in our simple model, 97% have skills in the first quartile, while 94% of the top 10% performers have skills in the top 10%. However, only half of the top 1% performers truly have the top 1% skill, and of the top 0.1% performers, only one in 10 truly has the top 0.1% skill.
Share of investors with skill matching performance, when chance = 5% of performance
And again, these numbers are based on a model where skills are 95% of success. In real life, or at least in the world of investing, I suspect luck plays a much larger role, probably close to 50%.
The chart below shows the share of skillful investors corresponding to their performance when skill accounts for 55% of total performance and luck for 45%. Only six of the 10 first-quartile managers truly possess first-quartile skills. And only one of the seven top 1% investors really has the skills of the top 1%. Oh, and on average, none of the top 0.1% investors have the best skills of the 0.1%. They are all there because they were very lucky.
Share of investors with skill matching performance, when chance = 45% of performance
And now remember that most, if not all, of the people reading this are in the top 1% of some sort. If you earn more than £50,000 a year, you are among the top 1% of the world’s income. If you live in the UK and earn more than £58,300 a year (before tax), you are in the top 10% in the UK, and if you earn more than £180,000 a year you are in the top 1%. In other words, you are in the top 1% of a country in the top 10% of all countries. And whatever it is, it’s probably more the result of luck than skill.
To learn more about Joachim Klement, CFA, do not miss Risk profiling and tolerance And 7 mistakes every investor makes (and how to avoid them) and sign up for his regular comments on Klement on investment.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
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