The one-day cricket match between England and New Zealand in 2019 will go down as one of the finest one-day matches in cricket history. Did England deserve the victory based on their talent? Yes, they deserved it. But were they lucky on the given day? Extremely Lucky.
In football, England lost the 2021 Euro cup Final to Italy 3 – 2 on penalties. That’s the other side of luck.
Success is an interplay between skill and luck. The famous book “Stay hungry Stay foolish” written by Indian author Rashmi Bansal covers inspiring, successful stories of Indian entrepreneurs. It is important to read these stories as they give hope to invest in business to create wealth. But taking a risk can have two outcomes. Success & failure.
The problem is nobody writes a book titled “Stayed Hungry Died Hungry”. A story about entrepreneurs who failed.
Stories are written by kings who succeed. And obviously, they are heroes in their story. Dead cannot tell their stories. The king who died also had a strategy.
Netflix churns out hundreds of series every year. Do you think Netflix knows in advance which series will be a wild success or which ones will fail miserably? Sacred Games’ Season 1 was a wild success whereas Season 2 had a dull response. Nassim Nicholas Taleb, famous author of the book “Fooled by Randomness”, explains that “mild success can be explainable by skills and labour. Wild success is attributable to variance. (Luck or randomness).”
The movie “Slumdog Millionaire”, with a relatively new star cast and shot in the slums of Mumbai, won eight Oscars awards including the best motion picture in 2009. How do you explain this?
The equation of luck and skill is fascinating.
For games like chess and casino, it’s simple to separate luck and skill. Chess is skill and casino is luck. But life, investing, and many other things, luck and skill are all jumbled up. It’s difficult to say that in the outcome, x portion was skill and y portion was luck. But in our head, the equation is simple. When things go right, it is natural to attribute it to skill but when things do not work well it is bad luck. Own success is a skill and others’ success is luck.
A growing number of studies show that most stocks (~96 per cent) do not outperform Treasury Bills in the long run. Equity returns are skewed. Most of the returns in the stock market are created by very few stocks (~4 per cent). Very few videos go viral, very few songs become hit, few people become superstars, very few get selected in Indian cricket team (out of population of over 136 crore)
. The beauty of multibaggers is that they all seem common sense investing in hindsight. To learn more about companies, watch the old interviews of the founders. You can see how vulnerable these companies and ideas were at that time. Even when private equity firms invest in unlisted firms, they diversify their money. It’s impossible to predict which idea will be the next Paytm or Flipkart or Byju’s.
A thought experiment
Let us imagine you were told a decade back that the entire nation would be glued to their mobile phones consuming data. All activities from buying groceries, to social interactions, banking, schooling, gaming, office work and everything else will move on the phone. You would have piled up all telecom stocks. The story played out, but most telecom companies are either out of business or suffering losses. Investing is not as simple as it seems.
With clean energy, traditional oil and gas companies are at risk. With electric vehicles, traditional auto companies are at risk. With tech companies entering, banks that have built physical branches are at risk. With online buying, conventional retail is at risk.
Which companies will survive and adapt in the future is difficult to say? If you have most of your money invested in your business or your company’s ESOP, then you are not diversified. Remember Enron or AIG or Lehman Brothers.
Equity mutual funds and index funds provide you with necessary diversification. But if you have 5 mutual funds and all invest in the same country, then you are not diversified. FIIs can move in or out from any country with a click of a button. Every country has a country specific risk. Read history. There can be Black Swan events. Diversify with international equity funds.
If you have all your investments only in one asset class, you are not diversified. Every asset class has cycles and sometimes these cycles can be very long. History shows equity, gold and even bonds going through long periods of low to negative returns.
Diversify across countries and across asset classes. Built a portfolio with a good mix of domestic equity, bonds, gold, international equity and REITs to manage risk.
Personal finance is about risk management. Ships are not designed and built for normal weather but to withstand extreme weather conditions. Discuss risk openly and understand how your financial advisor is managing risk.
(Amit Grover is AVP for Learning and Development at DSP Investment Managers. Views are his own)