Date: Fri, 17 Jun 2005 10:04:54 CST
From: michael@bcect.com (Michael Sullivan)
Newsgroups: misc.invest.financial-plan
Subject: Re: Luck or skill?
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Douglas Johnson  wrote:
> michael@bcect.com (Michael Sullivan) wrote:
 
> >You can look at probabilities for various results and see whether some
> >outlier over a long time is "statistically significant".  The problem is
> >that any given investor just doesn't live long enough to generate real
> >confidence that their good results aren't due to variance.

> How long do they have to live?  In other words, how many years do you need of
> good returns to have a 95% confidence it's not luck?

Depends on how good those returns are, relative to relevant benchmarks
and additional volatility accepted.

In my last survey of attempts to determine this, the number of people
with "outside of 95% confidence" results was about what you'd expect
given the size of the investing universe.

That's the problem.  If 100 million people all attempt to do something
for 30 years, 5% of them are going to end up with results outside the
95% confidence interval.  When it's investing, the 2.5% on the high side
become rich.

If you had picked 1 random investor in 1975 and over the last 30 years
they had achieved a 99th percentile result, you'd figure there was a
good chance that they had, in fact, outperformed due to skill.  But if
you just look around for people *today* that have done that well, you
would expect to find a few even if it's all luck, because they have
self-selected.

When researchers have tried in the past to "pick good investors" based
on various ways to measure their performance, and then looked at their
results into the future -- the "good investors" have rarely outperformed
their relevant benchmarks in the future as a group.  Nobody has come up
with a measurement of past performance, that has a statistically
significant chance to survive into the future -- Except for *bad*
performance.  At least in the universe of public mutual fund managers of
listed stocks and bonds.    

I know there are obscure corners of the financial world where people do
really beat the market due to skill (or perhaps just due to better
access to information), but we're talking about things that a typical
individual investor cannot easily do (or buy the services of someone who
does).

It's also true that some segments of the market have outperformed
others, but it's not clear that this isn't due to taking on greater
risk.


Michael