luck

Does Skill Really Matter in Stock Market Investing?

Dr Penny Pincher — Wed, 06 Dec 2017 09:00:07 +0000

My young son once expressed concern when I told him I had money invested in the stock market. Perhaps he had seen stories about blindfolded monkeys throwing darts picking better stock portfolios than "expert" traders.

"Buying stocks is just like gambling," he said.

"No, it isn't," I explained.

I am not sure my son was convinced by my explanation, and I began to doubt it myself. What made me so confident that my process of choosing stock market investments was better than random chance?

How lucky stock picks can beat the market

People tend to overrate their investment skills as their portfolio grows. Over the years, the stock market tends to go up and the value of anyone's portfolio — even a portfolio picked by a monkey — would likely go up. But the measure of a successful investor isn't merely getting a positive return on investment. Real success is beating the market by getting a return that is better than the market average. This is where the skill comes in … or does it?

Let's consider randomly selected stock portfolios drawn from the broader stock market. Most such randomly selected portfolios will perform near the overall rate of return for the market. Some of the stocks may perform better than average and some worse, but the ups and downs across the portfolio tends to work out to about average. But by pure luck, some portfolios will end up with more winners than losers and beat the market average. Sometimes these randomly selected portfolios do a lot better than the market average.

For some specific examples, let's simulate portfolios randomly drawn from a market with 10.5 percent return and a standard deviation of 20 percent after 20 years. Under these conditions, the average return portfolio value based on the broader market is $7,366. Here were my "returns" from eight randomly selected portfolios after 20 years:

$4,330
$34,603
$19,572
$9,971
$10,925
$1,482
$8,482
$3,460

You can see that five of our eight randomly selected portfolio beat the expected value of $7,366 from average market returns over 20 years. One portfolio (#2) beat the market significantly, achieving an annualized return of 19.4 percent and growing 4.5 times that of an average portfolio. This portfolio was selected by pure chance, but the performance looks like something that would take a financial genius to achieve. If you were lucky enough to put this portfolio together, people would probably be lining up to ask for your investment secrets to learn how you beat the market. And since you were so successful, you might believe you had actually figured it out!

Our simulation results show that by pure luck, an investor could end up with a portfolio that greatly beats the market. A dart-throwing monkey could pick a great set of stock picks by chance. Random picks can result in underperforming portfolios too, but people tend to notice the big winners.

We have seen how you can end up with a high performing stock portfolio by pure chance. Does this mean that successful investors are just lucky?

The argument for investing skill

As we have seen, it is possible to get lucky and beat the market. But some investors seem to beat the market consistently. It's one thing to get lucky once in awhile, but is someone like Warren Buffett just really lucky, or is there more to it than that?

From reports over the years, we can see that Berkshire Hathaway beat the market 39 out of 49 years, earning more than the market average rate of return. A 2015 paper by James Skeffington uses some simplifying assumptions to analyze the probability that such a run of success would occur by chance. In a simulation with randomly drawn portfolios of 500 companies to represent the S&P 500, Warren Buffett turns out to be luckier than the luckiest of the simulated portfolios by a factor of about 100x.

While this analysis does not conclusively prove that Warren Buffett has exceptional skill as an investor, it does indicate that luck alone is not likely to be the secret of Mr. Buffett's success as an investor.

Should you throw darts to pick stocks?

The conclusion that skill — not just blind luck — likely played a big role in Warren Buffett's investment success means you could potentially study up and make informed investments or find a fund manager that can consistently beat the market through skill. If you want a piece of Warren Buffett's action, you could buy Berkshire Hathaway at a premium or a similar fund at a discount. (See also: How to Buy Berkshire Hathaway and Other Blue Chip Stock for 17% Off)

But in general, past performance does not predict future performance. If you see a fund that is advertising good recent performance, it does not mean the fund will stay hot. It is impossible to know if a fund manager is good or lucky, and investment strategies that work now may not keep working forever.

You could follow Warren Buffett's advice and go with index funds with low expense ratios that take away some of the risks, expenses, and inefficiencies of actively managed funds. As Warren Buffett's famous $500,000 bet showed, a low expense index fund can beat an actively managed fund. This investment strategy allows you to be successful without luck or skill. (See also: Why Warren Buffett Says You Should Invest in Index Funds)

Like this article? Pin it!

This article is from Dr Penny Pincher of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

9 Bizarre Money Superstitions People Actually Believe

Emily Guy Birken — Tue, 16 May 2017 19:22:16 +0000

When I was about eight years old, my grandmother gave me a purse. Inside the purse was a dollar bill, which I tried to give back to her. I thought she had left it in there by mistake.

"No, no. That must stay in there," she told me. "You can't give a purse with no money in it, or else it will never have money in it. Money attracts money!"

That was my first introduction to the odd world of money superstitions. Grandma's belief that purses and wallets should always have at least a little money in them, especially if they are given as gifts, had been passed down to her from her Russian grandmother — although it is a superstition that can be found in many countries around the world. I have since met many people who follow this custom, including a small retail business owner who would place a penny in every wallet and purse she sold.

Money superstitions can run the gamut from the slightly lucrative to the silly to the downright bizarre, but they are always fun to hear. Here are nine common money superstitions that people take pretty seriously. (See also: Why Superstition Makes You Buy Insurance)

1. Itchy palms mean you are about to gain or lose money

According to the Palmistry and Hand Analysis website, an itchy right palm is a good thing, because it means you are about to receive money. Don't scratch that itch, or it will stop the money from coming into your life.

An itchy left palm, on the other hand (ha!), means you are about to lose money. To relieve the itch and protect your assets, you can rub your left palm on a piece of wood. This superstition is said to have originated from the Saxons — German tribes who settled in Great Britain during the Middle Ages. They believed you could cure diseased skin by rubbing silver on it.

2. Do not place your purse on the floor

This superstition is considered to be bad feng shui, because your purse is seen as a symbol for your wealth. Putting it on the floor is therefore a sign of great disrespect and disregard for your money.

Whether you believe that or not, there's a practical side to this credo. Placing your purse on the floor makes it easier for someone to snatch it or steal something from it.

3. If you have hairy arms, you're going to be rich

I first read this superstition in Adventures of Huckleberry Finn, when Jim tells Huck that hairy arms and a hairy chest are indicators of future wealth. But real estate mogul Barbara Corcoran also writes about this superstition in her book If You Don't Have Big Breasts, Put Ribbons On Your Pigtails. Her grandmother comforted her with this superstition when Corcoran was a teenage girl. Years later, she was delighted when the supposed link between her hirsute arms and her future as a wealthy woman came true.

4. Bird droppings bring great wealth

My father was completely bald for most of my life, and for some reason his shiny head seemed to be a magnet for bird droppings. As unpleasant as it was for him to have to clean digested bird seed off his head, someone would always be sure to tell him that getting pooped on by a bird was good luck.

In fact, getting graced by bird droppings is supposedly a sign that wealth is coming your way. In Dad's case, it certainly worked. He was a wealthy man when he passed away, which almost makes up for having birds play target practice with his head.

5. Place coins on a deceased loved one before laying them to rest

The more modern version of this superstition is to lay coins on the eyes of a deceased person before burial. There are two reasons for doing this. One has to do with the belief in many cultures that open eyes suggest that the deceased is fearful of the future because of misdeeds in life. The eyes are therefore forced shut quickly after death, and coins are placed on them before rigor mortis sets in.

Another reason comes from Greek mythology. In that case, the coins were intended to provide the dead soul with the money necessary to pay Charon, the boatman on the river Styx, for passage into the underworld.

Before placing coins on eyelids, however, many older societies would place a coin for Charon in a dead person's mouth.

6. A spider in your pocket will keep it full of cash

Spiders may be the leading cause of screaming and running away, but apparently some types of spiders can provide you with great wealth if you can force yourself to catch and pocket one. According to superstitions from Great Britain, Australia, Portugal, Trinidad and Tobago, when a money spider (one from the family of spiders called Linyphiidae) runs over clothes you're wearing, or if you catch such a spider and put it in your pocket, that pocket will never again be empty of money. Depending on how you feel about spiders, that may or may not seem like a good trade-off.

7. Say the word "money" when you see a shooting star

There are several different versions of this superstition, but they all say that you should utter the word "money" upon seeing a shooting star. Just as making a wish on a shooting star is said to grant that particular wish, saying the word "money" is said to bring you wealth. According to some versions, just saying the word once will be enough to bring more wealth into your life. Other versions claim you need to say "money" three times, or say "money" as many times as you can before the star fades away — because the more times you say it, the more money will flow into your life.

8. Only pick up pennies that are heads up

My friends and I grew up saying, "See a penny, pick it up, and all day long you'll have good luck." We learned this adage from the movie Grease, but it is apparently an old saying from England.

However, there are apparently more rules about picking up pennies than the one I grew up with. Pennies that are lying heads up are good luck, but pennies that are tails up will lead to bad luck and should be left undisturbed.

9. Don't whistle in your home

According to a Russian superstition, whistling while under a roof will cause you to whistle your money away. This is probably related to the Russian view that you should be pessimistic about future financial success, or else you will face bad luck for your hubris. Money is not a "carefree" issue to people who hold these superstitions, and whistling is one of the most happy-go-lucky activities you could engage in.

This article is from Emily Guy Birken of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Best Money Tips: Ways to Use Luck to Stretch Your Budget

Amy Lu — Fri, 15 Apr 2016 09:30:24 +0000

Welcome to Wise Bread's Best Money Tips Roundup! Today we found helpful articles on ways to use luck to stretch your budget, how to make your laundry routine more eco-friendly, and grilling tips for newbies.

4 Great Investments That Sounded Really Stupid in the 2000s

Damian Davila — Mon, 23 Feb 2015 14:00:07 +0000

Ridicule and high return are often positively correlated.

In the 1970's, there was the pet rock craze, which reportedly made $15 million in its first six months. Now fast forward to 1989 — would you have invested in the penny stock of a homebrew computer maker? Well, a $5,000 investment in Dell that year would have made you $4.5 million by the end of 1999.

History tends to repeat itself. Here are four investments that sounded really stupid in the 2000s, yet ended in big paydays for their early investors.

1. Santa Mail

If you're a fan of the TV show Shark Tank, you know that it takes a bold pitch with big numbers to impress the sharks.

Well, how's this for a pitch? "New York City's Operation Santa responds to about 500,000 letters to Santa every year for free. However, every year millions of American children write to Santa hoping to get a reply. My plan is to capture some of that market and charge parents about $10 for a personalized letter from the big guy himself! Are you ready to invest, sharks?"

This investment proposition sounded really stupid back in 2001 and it probably still does today. However, entrepreneur Byron Reese stuck to his guns and sold 10,000 letters in his first year of operation. His company Santa Mail has delivered over 350,000 personalized Christmas letters since then. With over $3.48 million in revenue over the years, he's surely having a Merry Christmas now!

2. Lucky Break Wishbone

After Christmas, Thanksgiving may be the second most important holiday in the U.S.

For those of us who love to enjoy a turkey on that day, we often have to fight for a chance to take a crack at the lone wishbone. In 1999, Ken Ahroni thought there had to a better way than fighting over the dinner table for choice turkey.

He devised a plastic version of the turkey wishbone and started selling them in 2004. His goal was to give folks a chance to make a wish with every single family member and friend — not only on Thanksgiving, but also the rest of the year.

His silly idea paid off. According to Investopedia.com, within two years his Lucky Break Wishbone Corporation was generating nearly $1 million in sales. You can find his product in several retailers, including Whole Foods, Fred Meyer, and Urban Outfitters.

Now, that's a lucky break!

3. Yelp

I bet you that you have already used or will use Yelp this week.

While Yelp is now a household name, it wasn't always so. Back in 2004, Jeremy Stoppelman and Russell Simmons were riding high on their successful stint at digital wallet company PayPal. Jeremy and Russell decided to leave Paypal and start their own "high tech" company.

What was this revolutionary idea that made them leave their cozy job? An email-based referral network dubbed Yelp. On top of its silly name, Yelp's original platform was so complicated that it didn't attract investors beyond the co-founders' friends and family.

However, Jeremy and Russell didn't give up and re-focused their company around a review feature. The rest is history. Yelp's user base grew from a total of 12,000 in 2005 to approximately 139 million monthly visitors in 2014. Despite its growing revenue throughout the years, there were still plenty of skeptics when Yelp went public in March 2012 at $15 a share. A $1,000 investment in Yelp then would be worth about $3600 now.

4. Slanket

When you think of sleeved blankets, you probably think of the Snuggie.

However, that's not the original wearable blanket. That title belongs to the Slanket. Created in 1997 by Gary Clegg, the Slanket was first used as a way to stay warm while flipping TV channels late at night in a cold dorm room. This investment idea sounded so stupid that Clegg waited until 2005 before fully committing to it.

His first run of 1,200 units sold out in seven weeks — a sign that he had to move really, really fast to keep the market. He enjoyed a successful run of QVC sales and was finally ready to introduce a cheaper version, called the Snuzzle, to big box retailers. Instead, in the fall of 2008 the Snuggie aggressively entered the market and became the new king of sleeved blankets. As of 2013, Snuggie has pulled in more than $500 million in sales.

While the Slanket is still selling, it has been estimated that the Snuggie has outsold the Slanket 20-to-1. The Snuggie has been such a hit, that there's even a version for pets!

If you snooze, you lose!

Ghandi said it best; "First they ignore you, then they laugh at you, then they hate you, then they fight you, then you win." These four ventures are proof that dedication to your ideas, no matter how much they may be ridiculed, pays off in the end.

What "crazy" investment from the 2000's do you wish you had jumped on?

This article is from Damian Davila of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Lucky trade-offs

Philip Brewer — Wed, 31 Dec 2008 13:08:11 +0000

I view frugal living as essentially hedonistic: I don't deny myself things. Rather, I spend less on the things I don't care about in order to be able to spend more on the things that matter to me. Anybody who does this, though, sooner or later (as soon as friends, relatives, coworkers, or neighbors notice some of that spending on things that matter more) is going to hear, "You're so lucky to be able to afford that!"

In my case, it's been leaving the regular job behind to write full time that's draw the comments about how lucky I am. Our occasional vacations to the islands have drawn comments on our great luck as well.

The first few times people suggested that my being able to write full time was "lucky," I was speechless. I wanted to explain that it's all about trade-offs. I wanted to talk about how, contrary to how people seem to view it, frugal living gives you more choices, because you're not tied to a high-earning job.

I didn't, though, because I learned long ago that most people don't want to hear it. Most people don't understand--and the ones who do often react as if I'm criticizing their lifestyle. (And maybe I am, although that's not my intention.)

Somewhere along the way I came up with a response that I'm comfortable with. I say, "It's not all luck." That way, if I run in to the rare person who does want to hear, all they have to do is ask. And everyone else is able to nod and pretend that I've partially agreed with them.

After all, they are partially right. I have been very lucky.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: