Investing is All Luck Says – I Beg to Differ

by Darwin on August 1, 2010

There was an interesting piece in the Wall Street Journal this weekend pretty much attributed investing success to “luck” over given periods of time, as opposed to investor decision-making.  While I tend to agree with parts of their assessment, I can’t go for it hook, line and sinker and I’ll tell you why.  I’ll lay out a few of the points they made, but I have plenty of first-hand experience demonstrating how savvy investors can exploit market panics and herding that occurs due to human nature, program trading, flash crashes and media influence.

Timing is Everything:

The article laid out the well-known fact that over some long periods of time, equities have performed spectacularly, while during other periods, they’ve been less than stellar – the last decade is a perfect example.  Here’s a statement which is true to a degree:

The biggest factor in long-term returns is how the financial markets happen to perform during the 30 or so years an investor puts money away for retirement.

Sure, a rising tide lifts all ships.  During the dotcom boom, you had to be an idiot to lose money in stocks.   Everything was going wild.  So, yes, while the broad market performance over a given period of time is a major determinant in outcomes, why not focus on optimizing your return no matter what the aggregate environment delivers? For instance, buying shares in Apple and during the 2009 crash made me 5 figure profits (~200% gains) in a year – that was WAY better than my performance would have been in index funds.  Also, along the way, I exploit market abnormalities – check out how I made 245% in a single day trading Apple options on their earnings call the other day.  It was a no-brainer to me, but little wins like this along the way do quite a bit to boost my returns over the “average”.

Historical Results are No Guarantee of Future Performance:

While this is true, what else do you go off of?  Sure, the prior decade wasn’t great for stocks and investors did just as well or better in bonds.  That has many naysayers shouting, “See, you should stay out of stocks, just buy bonds!”.  But they’re doing the same exact thing with a twist – overemphasizing recent results over centuries of public stock records; and also ignoring fundamentals.  How much lower can Treasury yields go?  Eventually they will rise and no economist worth their salt will disagree with that.  And when that happens, bond prices tumble since they’re inversely related.  Where will investors move assets?  Into stocks of course, just like they always have.

The article rightly points out that even over 30 year time periods, there’s no steady, “expected” return of even a balanced 60/40 stocks/bonds portfolio.  As this visual demonstrates, much depends on which year you started investing:

Again, I go back to what else is going on which IS within the investor’s control.  First of all, are they indexing and minimizing expenses?  Are they taking advantage of arbitrage opportunities that even routine retail investors can exploit?  For instance, check out how I saw an unmistakable market anomaly brewing between two gold funds and did a gold pairs trade to exploit the divergence in Net Asset Value until the overpriced leg came back to earth – some of the lowest risk, easiest money I’ve ever made.  And I posted about it in real-time.  Sometimes, it’s this easy.

Don’t Follow Fads:

This is true for people who blindly follow the herd and don’t know when a fad has run its course, which admittedly, I’ve been guilty of myself.  But take gold for instance. If the late-night infomercials and even an ATM in Dubai that can spit out gold coins didn’t signal a top, I don’t know what would.  And to add insult to injury, while there are perfectly acceptable gold ETFs out there with marginal expense ratios, many consumers have been duped into paying 35%-50% premiums to get their hands on the real thing, only to find that they paid close to double the actual melt value if they want to sell it back at some point in the future – and then pay a higher gold tax rate since it’s treated as a collectible when held in bullion as opposed to some ETF and ETN alternatives.  Buying ethanol stocks after the news was out on the subsidies and buying wind/green energy stocks after the party started proved disastrous as well.  However, in hindsight, what about people that got in on the beginning of each of these fads and gradually took profits along the way?  They outperformed the market big-time!  Gold outperformed equities during the last century and there were some green/ethanol stocks that were running up 100%+ per year while nobody noticed.  So, don’t “Follow Fads”, but Spot Fads – and exploit them.  CROX on the way up? Great. TASR on the way up? Great. But these were seriously stupid stocks that didn’t have the staying power or growth potential to support their exorbitant market caps.

So, while the article rightly points out the investors should acknowledge the fact that much of their success resides in the global economy and how stocks fare as a group, that shouldn’t be license to just sit there and set it and forget it in a vacuum.  How could you ignore shorting the Euro during its near-implosion and how can you ignore how Netflix is demolishing all competitors (I have it on my Wii and it’s an incredible model) – these are trends I’ve exploited and shared in my portfolio updates, and while individual stock investing isn’t for everyone (and it shouldn’t be), for those that do the research, understand markets, and can detach emotion from their decisions, it’s a very good way to boost baseline returns.  Even in lieu of individual stock trading, there are many broad based ETFs that allow you to trade on a secular trend.  China’s growth story?  The Fall of the West and Rise of the Rest?  My ETF blog ETFBase has a whole section on Emerging Markets ETFs.  I can’t even get emerging markets in my 401K.  These are trends that are tough to ignore, unless you think the US will be the sole financial superpower forever by adding $1 Trillion in debt every year or so with no end in sight.

In closing, while I’ve had my share of turkeys and many retail investors fail to “beat the street”, I’ve done well better than the indices by exploiting some of the opportunities and panics I’ve seen over the years and so can you.  But you can’t do it in a 60/40 portfolio that never changes.

Thoughts?  Is Investing All Luck?

{ 4 comments… read them below or add one }

Barb Friedberg August 6, 2010 at 3:56 pm

Although I’ve beat related benchmarks over time with a mix of index and individual asset investing, the amount of time and temperament required is not found in many. That said, there is an element of “luck” in every activity, so why should investing be any different?
99.9% of the population would do best investing regularly in a diversified mix of index funds or etfs; low cost and time commitment.


Darwin August 6, 2010 at 4:20 pm

Hi Barb,
I agree that most would be better off in low-fee index funds – set it and forget it. But then you’re relying solely on luck. I don’t believe luck accounts for every activity though. I have a good job not because of luck, but because I chose a tough major, worked hard and made good career choices. I make decent money blogging not because of luck, but because I work hard at it. I think much in life is self-determination.

As far as investing, while much is due to what’s going on in the general markets, I just pointed out a couple examples of where being aware of what’s going on in the market can make very high returns for given risk. For instance, I shorted Treasuries when they were yielding negative (unprecedented), I went way overweight on Apple when shares were below 100, exploited arb plays, short leveraged ETFs that lose value over time, etc. There are all investing opportunities that through some research, seem very risk-attractive to me, and I’ve benefited tremendously as a result.


Barb Friedberg August 7, 2010 at 7:56 pm

Hi again, You compelled me to continue the conversation….. Clearly, you are a smart and sophisticated investor, and I totally understand your thinking on the investing plays you made-well thoughtout with a reasonable amount of risk for the potential return.
Regarding the index approach-lots of empirical research supports the outperformance of index funds over actively managed funds- and it’s not luck which determines the long term results but the growth of the earnings and sales of companies in the market.


Financial Samurai August 7, 2010 at 2:36 am

Luck + proper asset allocation is what I say!


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