You’re looking at the Skill-Luck Continuum, created by Legg Mason investment strategist Michael Mauboussin in his new book, The Success Equation.
Based on quantitative and qualitative analysis, the Continuum shows is how much luck can explain the variance in results in different fields.
The results are fairly intuitive. You’re not going to get lucky and beat Magnus Carlsen at chess, nor is your office team going to get lucky and beat the Lakers, but sometimes a small-time investor can get lucky and beat the professionals. Investing still takes some skill, however, which is why picking stocks on a lark is throwing away money.
Mauboussin explains to us in an email:
[A]bsolute skill is not as important as the variance in skill. In competitive settings, absolute skill is obscured. For example, hitters and pitchers in baseball both get better, but they get better in lockstep. So the overall batting average stays pretty stable even as the players get absolutely better.
Basketball has more variance in skill in the players than some other sports (some attribute this to the heights of the players), which allows skill to be more important. Basketball also has larger than average sample sizes (possessions per game), the best players can play the whole game, and the ball can be in the hands of the best players a great deal. As a result, basketball is closer to the skill side of the continuum.
The variance in skill in investing is narrow and narrowing. There is differential skill, but it’s harder to detect than in basketball. Further, there is a major sample size issue – we just don’t get as much data as we do in some sports … Investing has less variance in skill–in part because prices reflect most of what’s out there–so luck is a large contributor to results, especially in the short term.
Understanding the role of skill and luck helps people to avoid making irrational decisions.
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