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Luck versus Skill in Investing: New Insights
from the World of Sports and Beyond
By Michael Skocpol
December 11, 2012


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Around this time of year, bragging rights and millions of dollars change hands as fantasy football league championships are decided in the final weeks of the NFL regular season. If you’re among the 32 million fantasy sports aficionados nationwide and you’re still in contention, it’s likely that you can thank a mix of skill (identifying the most promising players and drafting them to your roster) and good luck (avoiding injuries; having an unheralded benchwarmer become a star) for getting you this far.

You’ve also probably already internalized the core lessons of Michael Mauboussin’s new book, “The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing,” whether you realize it or not. Mauboussin, chief investment strategist at Legg Mason Capital Management and an adjunct professor at Columbia Business School, is best known for identifying cognitive biases that skew decision-making, particularly among investors. In his latest book, he set out to explain how skill and luck interact to determine outcomes across a variety of fields.

Predictably, he achieves mixed results. If “The Success Equation” leaves its readers with any clear message, it’s that skill and luck are so thoroughly intertwined in most disciplines as to be nearly impossible to completely separate. This is especially true in business and investing, where the playing field is especially complex and conditions are constantly evolving. (Mauboussin achieves the most success when he turns to sports, where stable rules and ample statistics offer him more fertile material.)

So if you expect Mauboussin, per the book’s title, to “untangle” the two, you’re likely to be disappointed. With the holidays approaching, your mental image should be that old box of hopelessly knotted Christmas lights in the garage – Mauboussin doesn’t so much untangle skill and luck as he plugs in the whole balled-up mess and tugs at the various jumbled strands. He finds numerous specific points of illumination, but he doesn’t even really attempt the impractical task of unraveling the entire thing.

That said, Mauboussin’s book offers a plethora of simple models and real-world examples to help readers think more systematically and intelligently about how luck and skill influence the results they observe – whether in their fantasy football playoffs or in their stock portfolios. And advisors may come away with an illustration or two or that will come in handy when explaining the vagaries of the market to clients who struggle with concepts like reversion to the mean.

A lot of the book’s insights, while somewhat intuitive to readers who already have a solid understanding of statistics, are rarely articulated as clearly as Mauboussin, an expert communicator, renders them. And a few illuminate genuinely surprising phenomena.

I’ll discuss a few lessons advisors may find useful in Mauboussin’s book, starting with one of its most counterintuitive conclusions – one that may offer ammunition to both sides of the debate over the merits of active investment management.

“The paradox of skill”

The popularity of fantasy sports is just one manifestation of a broader cultural phenomenon that’s been building to a crescendo for a while now – the heartwarming, public reconciliation of all those math nerds and athletes who didn’t get along in high school. We live in a moment when a movie about a number-crunching major league GM can star the likes of Brad Pitt and earn more than $100 million at the global box office.  And the leading statistical prognosticator of the moment, Nate Silver, honed his skills parsing baseball statistics before going mainstream as a political blogger.

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