Individuals who achieve remarkable success in business or investing often attribute their accomplishments to their skills and hard work. While these factors certainly contribute to their success, luck plays a pivotal role, especially when it comes to extreme levels of achievement. In fact, luck is so integral to extreme success that those who attain it can largely attribute it to luck alone. This is not meant to offend anyone, but rather a mathematical reality.
Allow me to elaborate.
We are all fascinated by the most successful individuals in the world. Jeff Bezos and Bill Gates serve as inspiration for many aspiring business leaders, and Elon Musk has become a household name due to his significant business achievements and controversial behavior. In the investment industry, we idolize legendary figures like Warren Buffett and star fund managers who consistently deliver impressive returns, such as Cathie Wood in 2020.
We understand that a combination of luck and skill determines the performance of investors and business leaders. However, what we fail to grasp is that while luck might have a minor role in general, it reigns supreme at the extreme ends of the spectrum.
To illustrate this concept, I conducted a simulation of 10,000 investors with randomly distributed skill levels ranging from 0% to 100%. Simultaneously, these investors possessed varying degrees of luck, also randomly distributed between 0% and 100%. Overall, this model attributes 95% of total success to skill and a mere 5% to luck.
If luck plays such a minor role in success, one would assume that becoming a top investor is primarily a matter of skill. However, this is not the case. The chart below displays the average luck score of our 10,000 investors as their performance progresses from the mean to greater and greater success.
Average Luck of Investors as Their Performance Improves, When Luck = 5% of Performance
On average, luck accounts for 50% of investors’ performance. Those who end up in the top quartile or top 10% tend to have slightly better luck than the average investor. However, those who find themselves in the top 1% or top 0.1% require an extraordinary amount of luck. Even though luck only contributes 5% to determining success, individuals must be exceptionally lucky to achieve such levels of performance.
This suggests that emulating the most successful investors or business leaders often means following individuals with lesser skills.
The following graphic reverses the approach and explores the likelihood that individuals in the top 25% genuinely possess top 25% skill. In our simple model, 97% of top quartile investors display top quartile skill, while 94% of top 10% performers possess top 10% skill. However, only half of the top 1% performers truly possess top 1% skill, and out of the top 0.1% performers, only one in 10 actually possess top 0.1% skill.
Share of Investors with Skill Corresponding to Performance, When Luck = 5% of Performance
These numbers are based on a model where skill accounts for 95% of success. In reality, or at least in the investment world, luck likely plays a more significant role, possibly around 50%.
The chart below illustrates the share of investors with skill corresponding to their performance when skill accounts for 55% of total performance and luck for 45%. Only six out of 10 top quartile managers genuinely possess top quartile skills. Additionally, out of the top 1% investors, only one in seven actually possess top 1% skills. Surprisingly, none of the top 0.1% investors possess top 0.1% skills on average. Their presence in this elite group is primarily due to sheer luck.
Share of Investors with Skill Corresponding to Performance, When Luck = 45% of Performance
Now, let us remember that most, if not all, readers of this article are in the top 1% of some sort. If you earn more than £50,000 a year, you are in the top 1% of global income. In the United Kingdom, earning over £58,300 a year (before taxes) places you in the top 10%. Furthermore, if your annual income exceeds £180,000, you are in the top 1%. Essentially, you are in the top 1% of a country that is in the top 10% of all countries. Whatever it may be, your position is likely more a result of luck than skill.
For more insights from Joachim Klement, CFA, be sure to check out his works on Risk Profiling and Tolerance and 7 Mistakes Every Investor Makes (and How to Avoid Them), as well as his regular commentary on Klement on Investing.
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All posts reflect the author’s personal opinion and should not be regarded as investment advice. The opinions expressed do not necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images/RomoloTavani
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