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Timeless Reading — Part Seven: Untangling Skill And Luck

This is part seven of a ten-part series on some of the most important and educational literature for investors with a focus on value. Across this ten-part series, I’m taking a look at ten academic studies and research papers from some of the world’s most prominent value investors and fund managers.

All of the material can be found under the ‘Timeless Reading’ tab on the menu bar at the top of this page. And if you don’t know where to start, we’ve put together a ‘Value Investors Must Read List’ of resources, which once again can be found under the Timeless Reading tab. Parts one through four of this series can be found at the links below.

Timeless Reading -- Part Seven: Untangling skill and luck

Are your portfolio returns down to skill or luck? Have you outperformed due to stock picking skill or just good luck, aided by the wider market rally? Conversely, has your portfolio underperformed due to a run of bad luck or poor decisions? It's hard to tell.

Those that outperform are more likely to say that it was their skill that yielded results. While those investors that have lagged the market are most likely to blame a run of bad luck.

Michael Mauboussin, the head of Global Financial Strategies at Credit Suisse Group AG (ADR) (NYSE:CS) Group AG, looked at the key distinctions between skill and luck in his book The Success Equation: Untangling Skill and Luck in Business, Sports and Investing. Mauboussin has also published a paper entitled, Untangling Skill And Luck: How to Think About Outcomes--Past, Present, and Future while he was working at Legg Mason Inc (NYSE:LM) Capital Management, and it’s this paper that’s earned a place in ValueWalk’s timeless reading series.

Defining skill and luck

“It’s important to define skill and luck before we get too far into the discussion. Skill is 'the ability to use one’s knowledge effectively and readily in execution or performance.' You can think of skill as a process, or a series of actions to achieve a specific goal. Luck is “the events or circumstances that operate for or against an individual.” Luck, in this sense, is above and beyond skill. Consider luck as a distribution that has an average of zero. By this definition, luck tends to be transitory.” -- Michael Mauboussin...


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