Luck vs. Skill in the World of Investing

The last player to hit .400 in Major League Baseball was Ted Williams in 1941 (he hit .406 that season). This means that “Teddy Ballgame” got 41 hits for every 100 at-bats he had that season. Last season, the best batting average in the big leagues was .354 (35 hits every 100 at-bats); in 2022, it was only .326. Now, think to yourself … do you believe that athletes are better or worse now than they were in 1941? Think of all the advances that have been made in travel, health, practice techniques, etc. to make athletes of today the best to have ever played. Ted Williams was a spokesperson for Lucky Strike cigarettes!

This phenomenon is called the Paradox of Skill, coined by Columbia professor Michael Mauboussin. As the skill level of all players in a particular field gets higher, luck becomes even more important. This same principle can be applied in the world of investing. 

There are over 200,000 Chartered Financial Analysts in the world, and that number has quadrupled since 2000. More and more people have become experts at picking stocks, making it harder and harder for unskilled investors to beat low-cost indexing (such as the S&P 500). In fact, there are so many skilled investors now that it has become difficult for even highly skilled investors to beat low-cost indexing. Luck has become more and more a factor in a skilled investor beating the market and picking the person(s) who might be lucky in the future sounds like a losing proposition.

The graph above shows that passive/indexed assets surpassed actively invested assets at the end of 2023. Also, the flows into passive assets have been unrelenting, while active assets flows haven’t kept pace.

This leads to an interesting conundrum. In the future, it may be possible that so many assets have shifted to the side of low-cost index investing that it will give those who have great investing skills an opportunity to beat the market more regularly. Where is that magical number of assets that will give active managers a leg up over passive? It’s too difficult to make that prediction. KWB will continue to monitor trends and data in the industry to determine the best investment approaches for our clients. Today, we believe (for most people) it’s best to stay out of the ‘luck’ game and stick with what’s working. 

~ Steve Gormley