People who are highly successful in business or investing tend to think of themselves as more skilled and hardworking than the average person. They certainly are on some level, but the more extreme their success, the greater the role luck plays in achieving it. Luck is so critical to extreme success, in fact, that those who achieve it do so almost entirely by luck. No offense to any readers, it’s just a matter of math.
let me explain
We are all enchanted by the most successful people in the world. Jeff Bezos and Bill Gates are inspirations to many aspiring business leaders, and Elon Musk has become a rock star thanks to both his enormous business successes and his personal antics. In the world of investing, 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 fail to realize is that while luck plays a minor role overall, it dominates at the extreme tails of the distribution.
To see how this 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%. In general, the overall success of this model is driven 95% by skill and only 5% by luck.
If luck plays such a small role in success, becoming a top investor should be mostly a matter of skill. But it isn’t. The chart below illustrates the average luck score of our 10,000 investors as their performance rises from average to increasingly successful.
Investors’ average luck as their performance improves, when luck = 5% of performance
Of course, the average luck for all investors is 50%. Those who finish in the top quartile or top 10% tend to have slightly better luck than the average. But investors who end up in the top 1% or 0.1% are very lucky. Although luck only plays a 5% role in determining success, to finish in the top 1% or 0.1%, investors have to be very lucky.
This also implies that the common approach of emulating the most successful investors or business leaders probably means following less qualified people.
The chart below reverses the process and explores the probability that those in the top 25% are actually in the top 25%. Among the top quartile investors in our simple model, 97% have top quartile skill, while 94% of the top 10% have top 10% skill. However, only half of the top 1% actually have the top 1% skill, and of the top 0.1%, only one in 10 actually have the top 0.1% ability
Share of investors with skills corresponding to performance, when luck = 5% of performance
And again, these numbers are based on a model where skill accounts for 95% of success. In real life, or at least in the investing world, I suspect luck plays a much bigger role, probably close to 50%.
The chart below shows the ratio of skill investors to their performance when skill accounts for 55% of total return and luck accounts for 45%. Only six out of 10 upper quarter managers actually have upper quarter skills. And only one of the seven top 1% investors actually has the skills of the top 1%. Oh, and on average, none of the top 0.1% investors have the skills of the top 0.1%. They are all there because they have been very, very lucky.
Share of investors with skills corresponding to performance, when luck = 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’re in the top 1% of global earners. 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 1% That is, you are in the top 1% of a country to the top 10% of all countries. And whatever it is, it’s probably more luck than skill.
For more information from Joachim Klement, CFA, don’t miss it Risk profile and tolerance i 7 mistakes every investor makes (and how to avoid them) and subscribe to his regular comment a Klement on investment.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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Joachim Klement, CFA
