No One Builds a Rocket Ship out of Luck
Malcolm Gladwell popularised the 10,000-hour rule, a rule that says you need to practice for that many hours at something if you want to become an expert. Though it has been challenged by some academics it makes intuitive sense in areas such as sport or music. Tiger Woods started playing golf at the age of 2. Vanessa Mae started the violin at the age of 4. There was some luck that came their way but mostly their mastery came from hours of grinding away.
In a recent podcast Morgan Housel talked about how massive amounts of effort create outlier success, certainly in most areas of our life. Tiger Woods and Vanessa Mae would attest to that, as would every successful entrepreneur.
It’s true in our relationships – the more effort we put in, the more rewarding they are. It’s true in general in our careers – the harder we work, the more successful we are. It’s true in fitness – the more we work out, the fitter we are.
Clearly there is a correlation between effort and output. However, luck matters too and when it comes to money and investing people systematically underestimate the role of luck.
Morgan uses Bill Gross as an example. Bill Gross was hailed as the ‘Bond King’ after managing the PIMCO Total Return Fund and producing market beating returns for 15 years. He once managed more money than anyone else in the world and is now a billionaire. And yes, of course some of his success was down to effort and skill, but Gross started his career at a time when interest rates were 15% and finished his career when interest rates were 2%. This is a serious ‘in the right place at the right time’ stroke of luck that is often overlooked (as interest rates fall, bond prices rise - a huge tailwind).
You may have been following the scandal in the UK surrounding Neil Woodford, one of the UK’s most famous and successful stock pickers. He built his reputation at Invesco Perpetual where he worked for 26 years before leaving to set up his own fund in 2014. It now has become clear that much of his previous performance may have been down to luck – he backed some big companies that did well and he stayed out of tech stocks in the dotcom bubble and banking stocks in the financial crisis.
Since running his own fund his performance has been abysmal. His fund has seen massive redemptions which he has become unable to fund and he has now stopped investors from withdrawing their money.
As Morgan says, no one builds a rocket ship out of luck but people do get lucky in finance. People make big bets that pay off (and people make big bets that don’t pay off). Separating luck from effort or skill is very hard, even over long time periods.
Unlike all the other areas of our life, there is no evidence that suggests the more effort you put into investing the better your output will be. In fact, the data shows that if we use the volume of trading as a proxy for effort then there is actually a negative correlation. The more you trade, the lower your returns.
It’s counter-intuitive that knowledge and experience wouldn’t translate into better results, but it seems that there are more and more examples of top managers falling from grace after superior returns are followed by extended periods of poor returns. It’s most likely an abundance of status, ego and over-confidence which plagues these guys (I can’t think of any examples of women). Investors eventually realise that although someone has made a lot of money, it wasn’t them. In Woodford’s case, his fund lost almost 7% over the past three years whilst his benchmark was up 33%. Despite that he paid himself and his business partner almost £37m last year. Even now the fund is closed and investors can’t get their money back, he continues to take around £100,000 in fees a day.
As Morgan always says, good money management is not about what you know, it’s about how you behave. “And behaviour is hard to teach, even to really smart people.”