Imagine a genie visits two people. He gives the first, Brett, $100 million. The second, Mike, also receives $100 million. But the genie places Mike under a spell. Whereas Brett is aware that he received his fortune from the genie, Mike believes that he has spent the last twenty years of his life investing in the stock market. Through hard work, he has netted $100 million so far.
To an accountant Brett and Mike are the same. But Brett and Mike inhabit much different mental lives. Brett continues his life as normal, minus a few indulgences. He remains parsimonious, knowing that his fortune might vanish just as fast as it appeared. Mike continues to invest confidently. One weekend, however, an oil crisis in the Middle East erupts and a bubble in the tech industry bursts. Mike loses all of his money. Devastated, he commits suicide and destroys the lives of those who loved him.
On the path to $100 million, we should never judge the quality of a decision based on its outcome. If a hypochondriac buys 10,000 bottles of Advil and the world’s supply of ibuprofen suddenly runs out, we would never praise him for his foresight. Luck can play a large role in success, especially with respect to investing. There’s nothing inherently wrong with that, of course, except when we attribute a lucky result to our skill and intellect. Once that occurs, overconfidence and risky decisions flourish, and the chances of blowing up increases.
In his splendid book The Most Important Things: Uncommon Sense for the Thoughtful Investor Howard Marks offers similar advice. “We all know that when things go right, luck looks like skill. Coincidence looks like causality. A ‘lucky idiot’ looks like a skilled investor. Of course, knowing that randomness can have this effect doesn’t make it easy to distinguish between lucky investors and skillful investors. But we must keep trying.”