Reducing The Element of Luck in Investing
Does luck play a factor in stock investing?
Well, the unfortunate reality is yes; luck does play a part in investing. Luck affects even the most seasoned investor and can have a huge impact on an investment return. As with anything we do in life, the element of luck cannot be avoided. It is merely something we have got to live with.
Having said that, we can reduce the element of luck in our investments by making sound decisions. Investing is a mix of skill and luck, and by using a few simple strategies, we can tilt the odds of good returns in our favour.
Without further ado, here are three ways to reduce the element of surprise and luck in our investments.
Strategy 1: Think long-term
The late Benjamin Graham once said that in the short run, the stock market is like a voting machine but in the long-term, it is like a weighing machine. This means that the stock market can be irrational and act like a popularity contest in the short-term, making it volatile and difficult to predict. While in the long-term, the market will reflect the true value of the companies behind the ticker symbol.
Therefore, to reduce the element of luck, we should avoid thinking of making a quick buck in the short run. Instead, we should invest for the long-term where the stock market is more predictable and will eventually reflect the true value of our investments.
Strategy 2: Do your research
Doing your research on stocks before you make your decisions is vital. Unfortunately, many investors do not perform sufficient due diligence before they invest. They simply rely on “hot tips” from friends or choose a stock that has been mentioned by their stockbroker.
If we do not do sufficient research, we are willingly letting luck play a major role in our investments. To avoid this, we should take a thorough look at each company before we invest. This reduces the element of luck and increases the amount of control we have on our investments.
Strategy 3: Know the difference between luck and skill
It is vital that investors learn to differentiate skilful investing from luck. However, this is easier said than done. Many investors (myself included) may suffer from what is known as attribution bias. This form of bias makes us attribute good results to ourselves and bad ones to factors outside our control. As such, we are in danger of developing misconceptions about our investment strategies or investing capabilities.
On the contrary, if we can accurately differentiate good investment strategies from luck, we should be able to constantly make good decisions and tweak our investment philosophies so that we can reduce how much luck plays a role in our returns. A good way to achieve this is by writing down the reason for each investment decision and knowing why you bought the share in the first place. If your thesis still holds true in the future, you will know that your good returns were more to do with skilful investing, rather than luck.
The Foolish bottom line
The unfortunate reality is even the best investors have to deal with luck playing a part in their investments. Thankfully, if we stick to sound investing strategies, we should be able to take control of our investments, and in turn, reap the returns for the longer term.