Luck Or Skill? What Are Your Investment Outcomes Due To?

The first time I made some money in investing, I gave myself a mental pat on the back for making the right investment. It was only when I started losing money that I realized maybe my first gain might have been pure luck.

My first investment was made before I really understood what investing was, and even before I started tracking my investments. All I did back then was to read some news, follow some “hot tips”, and pumped in my money.

I learnt my lesson the hard way. I also learnt that it is important to recognise if my investment results are due to skill or luck.  Perhaps more importantly, I learnt why we even need to learn to identify whether the investment outcome is due to skill or luck.

Why? Why? Why?

So the first question, why? Why is it important for us to differentiate luck from skill?

Because it is impossible to be right 100% of the time. Even Warren Buffett can be wrong sometimes.

In every investment, there is a risk that things might not turn out the way we expect them to turn out. By tracking our decision making criteria and process, we will be able to obtain a clearer picture of whether the final outcome (a rise or drop in share price) is within our expectation, or due to events that we could not have or did not envision.

Over time, we can improve our investment process and learn from our mistakes to become a better investor. Without tracking the decision making criteria and process, one might incorrectly assume (like I did), that all our gains were due to skill and losses chalked up to bad luck. 

This is a dangerous situation to put yourself in as it creates over-confidence over time, and one might start to take on unnecessary risk.

How do we differentiate?

A very simple method is to create a note for every investment that you make. Write down why you are investing in this company and what are the risks you are exposure to in that particular investment. This way, when a new development arises in the company, we can review easily whether our initial thesis still holds or we might need to adjust our expectations on the company.

Foolish Summary

Investing is a dynamic process. Being able to identify the reason behind our investment results, whether it was due to skill or luck, give us a feedback loop we can rely on to improve our investment process. This makes future investment results more likely a result of skill rather than luck.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim does not own any company mentioned above