Don’t Confuse Luck and Smart Investing

A recent article by Bloomberg columnist Barry Ritholtz warns investors that although huge wins get more attention than smaller, “routine” wins and losses, those windfalls don’t necessarily represent smart investment decisions.

“Focusing on a single outcome versus a repeatable process raises more questions than it answers,” Ritholtz writes, including the following:

  • Were the results of the winning trade statistically significant?
  • Was the trade the result of luck or skill?
  • What is the long-term record of the investment approach?
  • Does the trade represent a repeatable strategy?

Ritholtz explains that focusing on single investment outcomes represents a combination of human behavioral biases, the most important being survivorship bias—”how many trades that were losers were not included in the discussion?” Big trade winners make headlines, he points out, but the “day-to-day run-of-the-mill wins and losses do not.”

If investors want to speculate, he says, it’s better to take a small portion of assets and “dump them into a separate account. Label it ‘speculative fund’ and do whatever you want with that capital: become a angel investor, buy microcaps, trade options, whatever.” 

The article concludes with Ritholtz’s warning to investors: “Never confuse lucky gambles with a good investing strategy.”