I keep running across new versions of the debate about “Luck versus Hard Work“.  My first awareness of this topic came from Malcolm Gladwell’s book Outliers, which I read about 10 years ago, but I’m sure it goes much further back in history.  The basic question behind the luck-versus-hard-work debate is whether a person’s success is determined more by random chance events (luck) or the willingness and ability to put in prolonged and concerted effort (hard work).

Advocates for the luck side of the argument argue that successful people were often born into better economic and social conditions.  America’s favorite investing Uncle, Warren Buffett, called this the “ovarian lottery”.  He counts most of his own success to being born a white male in the U.S.  And I’d add that because his father was a successful businessman, investor, and congressman, young Warren was raised in extremely privileged circumstances.

But the advocates for hard work counter that without a foundation of hard work, most lucky opportunities will pass you by.  Let’s say you randomly meet someone new at a party, who offers you the easiest, high-paying job in the world—as long as you meet some minimal educational requirements.  But if you never put in the hard work to get a decent education, you can’t take the job, regardless of any prior privileges you may have enjoyed.  The same argument applies to my lucky eggplant pictured above.

Conceding the Debate

I won’t try to settle the work-versus-luck debate in today’s post.  For one reason, it’s easy to mangle words to win either side of the argument.  For example, hard work advocates can argue that “luck” doesn’t really exist.  And luck advocates can ask the same questions about the true meaning of “hard work”.  And how do you define “success”?  Is it relative, like being the highest-paid ditch digger in the entire State of Nebraska?  Or is it more absolute, like becoming the CEO of a Fortune 500 company?

However, I think the whole debate is fundamentally flawed because it assumes a false dichotomy.  It’s like asking whether obesity is mostly caused by carbs or fats.  The answer to most false dichotomies is that both factors are at play and both can be determinative under particular circumstances.  I can get fat eating too much bread or too much butter or too much of both.

Even so, the luck-versus-hard-work debate illustrates some key aspects of successful investing. It seems obvious that luck won’t consistently lead to investing success, while hard work probably will.  But in this case, the obvious is misleading because it falls into the same old dichotomy trap.

Does Hard Work Apply to Investing?

Uncle Warren is also credited with saying, “Investing is simple but not easy.”  But when he says “not easy”, he’s not referring to hard work.  He’s talking about how hard it is for most people to manage their unproductive emotions.  For example, you might intend to buy and hold stocks for 10 years.  But if the stock market plummets a few months after you bought in, fear will urge you to sell everything before it’s too late.  Similarly, it’s been hard this year to resist that greedy urge to jump into Tesla stock or Bitcoin.

Further, Mindfully Investing is dedicated to the idea that because successful investing is relatively simple, once you understand the fundamentals, additional hard work won’t help much.  In fact, evidence strongly indicates that hard work to gain more knowledge, information, and analysis usually causes inferior returns.  Specifically, 80% to 90% of actively managed funds fail to beat their relevant indices!  And most actively managed funds are run by well-educated experts, who presumably work very hard gathering the latest information and devising innovative analyses to find the very best investments.

So, for investing, the flip side of luck is better described as “discipline” rather than “hard work”.  The more disciplined and unemotional you are, the greater your chances for investing success.  More specifically, mindful discipline means recognizing and feeling those emotions without rashly acting upon them.

Does Luck Apply to Investing?

Now let’s look at the luck side of the equation.  Without slipping into the semantics debate, it’s common sense to say that some aspects of investing involve luck, particularly given that it’s so often compared to gambling.

At the simplest level, it’s obvious that no one knows with any consistency whether the stock market will go up or down tomorrow.  Another debate has raged for decades about the randomness of the stock market.  But for our purposes, I think it’s common sense to say that the direction of the market over the next few days is mostly about luck.

Similarly, no one knows whether next year’s markets are going to be impacted by a global pandemic, world war, economic turmoil from infinite sources, or meteor strikes and massive solar flares for that matter.  So, if we can’t predict the direction of entire markets, I think it’s reasonable to say that predicting the movements of individual stocks is even more difficult.  One of the many examples of the difficulty of stock picking is when even Uncle Warren couldn’t predict the on-rushing failure of Kraft Heinz, which now seems entirely obvious in hindsight.

So, it seems that both discipline and luck apply to investing, but which is more important?

Was It Luck or Discipline?

Like the examples above, I’ve experienced dozens of such lucky/unlucky incidents in my own investing life including these two:

1. I bought a chunk of Bank of America stock during the great financial crisis.  The next morning Uncle Warren bought a gargantuan chunk of the same stock.  The stock price immediately jumped, and today, the price is four times higher.
2. I bought shares of a tech mutual fund in early 2000, and less than a month later, the tech bubble started to burst.

I think most people would agree that these incidents seem mostly like random events.

But I can just as easily frame them this way:

1. I had the discipline to buy Bank of America at a low price when the markets were panicking over the entire banking system.  I was paid handsomely for my discipline when others finally came to their senses.
2. I was undisciplined in acting on my greed for amazing tech stock returns at a time when the market was clearly in a bubble.  I paid dearly for my recklessness.

These sorts of gray areas make the luck-versus-hard-work question readily debatable.  And it suggests to me that both luck and discipline play important roles in most investing decisions and outcomes.

The Spectrum of Investing Luck and Discipline

I’d go so far as to argue that almost every important aspect of successful investing involves some amount of both luck and discipline.  In fact, I think we can place them on a continuous spectrum from mostly (but not entirely) luck to mostly discipline.  Here are some examples.

Mostly luck – Trying to “beat the market” or “time the market” is mostly about luck.  As I noted above, only about 10% to 20% of active managers outperform the broader market over a period of a few years.  And the longer track record shows that almost no manager can repeat that outperformance consistently, which strongly suggests that luck was the key for anyone who says they once beat the market.  For similar reasons, picking individual stocks to get rich quick is nearly impossible because even the best stock-pickers fail to consistently beat randomly selected stocks.

Luck heavy – Even if you invest via low-cost index funds, the returns you get will be a combination of your asset selection and the random aspects of asset performance in any given period.  I showed in one post that my all-stock portfolio had a meager 4.8% nominal annualized return over the last 20 years as compared to a historical average of about 9.2% for stocks.  It turns out that my stock returns were worse than the stock returns from 96% of all historical 20-year periods.  Bad luck indeed!

And even though asset mix (or diversification) is probably the best way to balance risks and returns, over the same 20 years all of the most common stock/bond portfolios have produced similarly meager nominal annualized returns in the 5% to 6% range.  Even the most disciplined and cleverly devised asset mix can be throttled by back luck.

Equal mix – The whole idea that disciplined diversification helps manage risks is also riddled with luck.  Perhaps you have bonds in your portfolio to avoid big drawn downs when the stock market crashes.  But you don’t know ahead of time whether those bonds will even have a chance to perform that risk management function.  For example, from 2010 through 2019 the U.S. stock market had no major crashes.

Similarly, it’s often posited that bonds are a better hedge against unexpected inflation spikes than stocks.  But a detailed look at the global historical data shows that the inflation hedging performance of bonds and stocks has been highly overlapping, particularly when statistical uncertainties are taken into account.  A disciplined diversification plan is wise, but you also need some luck to avoid almost any type of risk.

Discipline heavy – While buying active funds and stock picking has a 10% to 20% chance of temporarily boosting your returns, minimizing “friction” from costs and taxes is a pretty predictable way to boost long-term returns.  It only requires the discipline to search out funds and assets with lower costs and tax potential, while avoiding other unnecessary brokerage and adviser fees.  However, there’s still some luck involved because taxable events from funds can be somewhat unpredictable and fund costs can unexpectedly rise (or decline) over time.

And just as luck can cause relatively good or bad returns for a diversified portfolio, the correlations between various assets within a portfolio can turn on a dime.  While history may show that one asset usually zigs when the other zags, that might not happen in the future.

Mostly discipline – I’ve already suggested that handling our emotional reactions while investing involves the most discipline and the least luck.  But even here, luck plays some role.  Some lucky investors will never have to weather severe market turmoils, while other unlucky investors may have their emotional control put to the test over and over again.

Having emotional discipline is also key to holding investments for the long-term, which improves the odds of investing success.  But here too luck may intervene, but not in the form of market turmoils.  You may encounter many other personal finance disasters that, in aggregate, are surprisingly likely to occur in one investing lifetime.  You could be required to unexpectedly sell your investments due to things like long-term medical disability, higher education costs, long-term unemployment, legal troubles, divorce, bankruptcy, and criminal fines/imprisonment.

Finally, to gain the potential benefits available from re-investing and rebalancing, you must have the discipline to conduct these activities on a regular and consistent basis.  Particularly in the case of rebalancing, the rewards you hope to reap in terms of reduced risks or additional returns may fail to appear because of those same random variations in returns and correlations over time.

Conclusions

It’s mindful to say that most things aren’t black or white.  And that’s why the idea of “gray areas” is just as prevalent in our culture as our love for parsing dichotomies.

The luck-versus-discipline debate highlights that both factors play a role in almost any investment decision and outcome.  In my view, luck is the most frustrating part of investing.  Almost any thoughtfully devised investing plan can be undermined by streaks of bad luck and combinations of bad events.  Fortunately, because we’re talking about luck, good outcomes are often just as likely as bad outcomes.  And just like my lucky eggplant, taking a disciplined approach to investing allows you to reap the benefits of those good luck opportunities when they happen.