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Investing Is More Luck Than Talent (nautil.us)
272 points by dnetesn on Jan 21, 2017 | hide | past | web | favorite | 207 comments

I've read a bit into econophysics. In stat mech, the exchange of energy between atoms is assumed to be random. When the exchange of energy is random, the resulting distribution of energies is a Gibbs distribution, which means that the probability of atoms with higher energies falls off exponentially.

The application is that if you replace energy with money, and atoms with people, then the same equations hold for a model of people who randomly exchange money. Therefore if investments were truly random, you would expect the distribution of investors' wealth to follow an exponential distribution, not a power law! This directly contradicts the article.

Interestingly enough, the bottom 99% follows an exponential distribution, while the top 1% follows a power-law, and the transition is very sharp (eg, wealth plots have a "kink" in them).

Brief introduction to econophysics for the mathematically inclined: https://arxiv.org/abs/0709.3662

Thanks for the paper, very interesting. All the below is total speculation as I am no 1%er ;).

Curious that there's such a sharp change in distributions. It seems like the top 1% participate in a very different sort of financial network than do the remaining 99%. Since the majority's wealth follows such a basic physical theory, their organization must be completely unstructured.

For the 1%, then, the question is what the structure is. It might be 'scale free' network [1], or fractal, so it could be due to preferential attachment [2], which would mean those who have lots of money find it easier to make more money (via things like investments or rent-taking), or due to competition between fit nodes [3], which would make sense in that those in the 1% are likely to be merging / acquiring others.

I guess what this means isn't too surprising: if you aren't in the 1% now, you need to claw your way in before you can take advantage of these network effects to grow your wealth in any meaningful way. If you aren't in the 1%, you might be successful, but it will be mostly due to luck.

But I wonder if the network effects can be taken advantage of without the wealth to start. Following this line of thinking [4], the wealth flows due to social networking, not due to financial networking. If you can connect with the 1%'s social sphere, you stand a much better chance at becoming a part of that financial class.

[1] https://en.wikipedia.org/wiki/Scale-free_network [2] https://en.wikipedia.org/wiki/Preferential_attachment [3] https://en.wikipedia.org/wiki/Fitness_model_(network_theory) [4] https://www.quora.com/What-is-the-most-effective-yet-efficie...

Right, power laws are extremely common, and all it says is that some aspect of the distribution is scale-invariant, but without saying why. For example, most companies are scalable, so it's no surprise that company valuations follow a power law. And since investors/founders own such large shares of companies, that would help explain why the 1% follows a power law. But as this article claims, if people gamble on log-scales, that would also create a power law. Power laws are so common and general, I find it difficult to believe that a power law is evidence of one way or the other.

Thanks -- does the fact that the top 1% and bottom 99% show different distributions not imply they are gambling on different scales though? Is it as simple as the 1% gamble on a log scale and the bottom 99% gamble on a linear scale?

> as I am no 1%er ;).

If you are usual HN demographic I can guarantee you actually are. 32k/year is all it takes: http://www.investopedia.com/articles/personal-finance/050615...

While it's always important to keep this in mind at the global scale, most Americans use "1%" colloquially to describe the top 1% of United States citizens.

I suspect the downvotes are from people who assume you are intentionally misunderstanding the parent

No sure I get it. It seems people don't like being reminded that whilst they're very keen for people richer than them to share their wealth, they're generally very reticent to share their own wealth with people poorer than they are.

I just thought your comment was off-topic, is all. The comment you replied to, and all of the comments before it, were referring to the American 1%er, not the global 1%.

However, I like to think of a downvote is paperwork, not an insult. It's a great point, I just think the conversation flows better without it.

This accounts for why socialists change their minds after making money.

That's interesting. I was referring to 1% w.r.t. the USA, where the cutoff is actually ~250 k after taxes and adding back transfers. http://www.economist.com/node/21543178

Really brings to light how bad global inequality really is!

So through a US lens, I'm guessing a certain percentage of HN readers who work in senior positions in the valley or NYC would be 1%, and of course a random assortment of other readers, but the vast majority of software engineers etc. would NOT be 1% on a single income.

I would assume that the exchange of energy between atoms is assumed to be independent in addition to being random. And by independent I mean that how much other atoms have exchanged energy with a particular atom does not have effect in how many atoms are likely to exchange energy with this particular atom. (Or, to be more precise, atom that has received energy from other atoms is not more, but _less_ likely to get energy from next encounters with other atoms)

But that does not hold in society. Preferences of people are highly dependent. If a singer has gotten praise from one person, it is more likely that s/he is getting praise from the next one as well (assuming these can share their preferences), and by more I mean more than what would be expected from singing talent alone. I am quite sure there was a social psychology research on specifically this example, how people rank music in groups, but for some reason I can't find it from google just now.

From the investment point of view, I think Piketty showed that larger investors seem to get better returns on their investments. You can debate causality, correlation and luck here probably endlessly, though.

I'm pretty sure this is the research report about how social influence determines which songs are likely to become hits:


Yes. Thank you.

Now, I am quite confident I have not uttered word "Piketty" anywhere else in any way (not from my mouth nor keyboard) in a long time. But now my Facebook feed is filled with advertisements to buy piketty's book. If this is not an anecdote, how do they do that?

I wonder if opportunities follow an exponential distribution. Then it's a matter of having the talent and ambition to capitalize on those opportunities. Although I don't know if a "talent distribution" exists such that its joint distribution with an exponential yields a power law.

My understanding is that the "kink" represents the transition point where people are making money from ownership of things (investing) rather than labor. In the investing world, the more money you have, the more money you can make, which gives a different kind of law than one in which money is just transferred randomly.

Explaining the top 1% is exactly the goal of the article:

"Could the differences between the very rich and the hugely rich [...] be the result of pure, dumb luck?"

So if the model you're looking at indicates power law distribution at the top, that seems to lend further support to the author's thesis.

I'm going to guess that insider trading is that top 1%, then, or most of it. Some trading on insider knowledge (such as when you sell a stock, depending) is perfectly legal, or at least wholly unpreventable or unprosecutable, of course.

Those in the bottom 99% of investors may still be capturing at least some of the increase in world wealth over time. Then again, maybe not: or not much. I'd have to read the article to know if the answer to that question is there, and I can't afford the extra time, alas.

It's almost as if human interaction can't be reduced to a Gaussian distribution... How strange.

Very interesting. I'd be curious to see a subset of this data related to venture capital, where there seems to be a high proportion of 'professional investors' -- although funding from friends, family, and personal savings certainly plays a role in Angel rounds.

Regarding your penultimate paragraph, isn't this just saying that for the most part, to make good money, you have to be lucky, whereas to be extremely rich, you need to be lucky and good at what you do?

Is there any reason to believe that econophysics provides a better model of reality than the article's informal model?

The equations from physics say "if we have some quantity X distributed among bins Y, and X is randomly exchanged between pairs of Y over and over, then P(bin y has amount x) is proportional to exp(-x)". In physics, X is energy and Y is atoms, while in economics, X is money and Y is people. If the money were truly being exchanged randomly, then the distribution should look exponential, that is, the probability person p has money m is proportional to exp(-m). What we observe is that the probability of having money m is actually m^(-alpha). Therefore the money is not being exchanged randomly, and the richest agents probably aren't lucky.

"What we observe is that the probability of having money m is actually m^(-alpha). Therefore the money is not being exchanged randomly, and the richest agents probably aren't lucky."

No, it means that you're using the wrong model. There are lots of models of "random" behavior. You can't just pick one out because you like it, and conclude that a system isn't "random" because the model you've chosen doesn't fit the data.

The article isn't especially convincing either, but at least they're describing a model that looks somewhat like money, and produces a distribution that matches what's observed in reality. You're describing a model that looks like atoms, and concluding that money isn't random because it doesn't look like atoms.

Is that a zero sum game? What happens if you add a heat source to the model?

Well there are several things that are incoherent about the article's application of this model.

1. Coin flipping is not a fit analogy, despite the fact that it's parroted in financial discussions ad nauseum. Take this quote from the article, for example:

Maybe the string of investment and managerial decisions that made one person’s company successful, and that seem so very wise in retrospect, were actually just the entrepreneurial equivalent of flipping a coin 20 times and getting all heads. The chances of that happening are about 1 in 1 million, so if enough people try it, someone is bound to get lucky and look like a coin-flipping genius—purely by chance.

What? How do you map the theoretical probabilities of individual entrepreneurial decisions to the chance of a heads or tails on a coin flip? Is the chance of getting into YC 50%? Is the chance of securing venture capital in a Series A round 50%? How about? This is before we even consider that the theoretical chance for each decision will obviously not be the same for everyone, whereas a coin flip is. This is important because it's not falsifiable if we can't map decisions to probabilities. It's also important because the numbers could be wildly different. If each entrepreneurial decision has a 50% chance of success, that might result in a 1 in 1 million chance of getting rich. But what if the actual chances of success for each entrepreneurial decision in lieu of the coin-flip mapping result in a 1 in 4 quadrillion chance of success? One result indicates that essentially all successes could be due to chance, the other suggests the opposite.

2. The author uses very fuzzy measurements with no empirical basis in reality to support the model. For example:

To make the game more realistic, assume that if investors’ wealth declines below some level they have to drop out of the game, and are replaced by newly rich players emerging from the middle class. Eventually, the game will reach a kind of equilibrium—one in which the number of players going up is always balanced by the number going down, so that the overall distribution of wealth reaches a steady state and doesn’t change anymore.

Wait a second, why are we assuming that this game reaches an equilibrium? We can't just use textbook economics here - there is no reason to assume the "game" won't be weighted towards more players dropping out than moving up or vice versa.

3. The author tries to repair the issues with chance being theoretically equal in my first point with the following:

Still, it is possible to get a crude sense of the effect of talent by modifying the investment game to include two types of players. Normal investors are just like those in the first game: They flip a coin with heads yielding a return of 30 percent, and tails producing a loss of 10 percent. But the talented investors are more skilled at playing the market: They earn slightly more than 30 percent when the coin comes up heads, and lose slightly less than 10 percent when the coin comes up tails. Now we set the players loose and ask an empirical question: How big can this “talent differential” be and still stay statistically consistent with the power law wealth distribution we see in the real world?

Where are these numbers coming from? How are these a rigorous, empirical model of talent and the subsequent chance differential? By this point in the article the entire game is becoming so "in the clouds" that it doesn't have any basis in reality anymore. It's like I came up with a "law" based on one extremely convoluted thought experiment and attempted to extrapolate it to the entire market in real-world conditions.

Basically, the author's model is narrow in some places, vague in others and overall does not empirically prove the premises it attempts to build upon. He hand waves the (extremely common) power law distribution as a sort of magic wand that smooths away all the lack of rigor. There's just not much evidence that the model reflects the real world.

Thanks for the paper. Do you have suggestions for other reading on econophysics at a similarly accessible level?

very good paper from first looks! thank you

This article basically repeats old economic saws of dubious validity. The counter argument is Warren Buffett. Last I looked at it (going back to his Buffett Partnership days), he beat the market every year but one for his first 30 or 40 years. Even better, he was beating the market by an average of 20% a year during his partnership days, and something like 10% a year during his first 20 years running Berkshire Hathaway.

It's not only statistically impossible for Buffett to be a fluke, it's statistically impossible for him not to possess a a skill providing a substantial edge in market investing. Not a "1% a year" type skill.

Nowadays and for the last 20 years or so, Buffett has been managing hundreds of billions of dollars. The immense size of his portfolio restricts his opportunities to a far smaller pool of potential investments and his edge over the market has clearly declined because of that restriction. But he's still beating the market the vast majority of the time.

There are plenty of people who disagree about Buffet - Nassim Taleb who wrote "Fooled by Randomness" is among of those. Out of all the people who started investing in stocks in the 50s, it's not surprising that at least one of them turned out to be among the richest people in the world and kept getting it right every year.

If you have enough people throwing coins, you're going to get some people who keep getting heads over and over. Those few people who have a superior coin-tossing technique are probably not going to end up anywhere near the top - This is especially true if you believe in the rhetoric that people of high talent are "very rare".

The sheer masses acting out of randomness will always beat out the few "very talented" individuals.

In "Fooled by Randomness", the author alludes to the idea that the top people at any given time in any given field often got there through very little talent - It just happens that their approach was a good fit for their field at that particular time - As soon as some "black swan" event happens (and they always happen, eventually); these people tend to lose everything very, very quickly.

Also, the reason why Buffet gets it right most of the time these days is the same reason why George Soros gets it right most of the time; whenever either of these famous investors buys any stock, it becomes big news then all these other wealthy investors follow suit - Soon enough you have half of humanity rooting for/against that specific company/security so anything they do becomes a self-fulfilling prophecy.

>There are plenty of people who disagree about Buffet - Nassim Taleb who wrote "Fooled by Randomness" is among of those.

I can't find the source, but I believe Taleb was misquoted (or misinterpreted) on Buffet. Taleb indeed makes the general argument that most high performers are just lucky. But he doesn't say that all are. He just says: you can't tell.

As for Buffet, he complained he hadn't meant Buffet was unskilled. He meant Buffet was skilled and had luck. Which is a plausible interpretation. You likely need skill to get to Buffet's level. But those with the skill of Buffet don't all end up at Buffet's outcomes: Buffet would be at the high end of the distribution of those that had his level of skill to work with.

At least that's how I interpreted it. I believe Taleb's subsequent commentary on this was in Black Swan or Antifragile. It involved the phrase "for Baal's sake" when complaining about how people had interpreting him as saying "Buffet is pure luck".

I didn't claim that Buffet is unskilled either. He was always well qualified to do his job. But his success doesn't necessarily say much about his ability.

I don't think it's really a useful thing to think about. Are there good writers, or just qualified writers who luck into writing the right stuff at the right time? You can apply that logic to almost anything.

I'm both a fan of Taleb and Buffett. That said, Buffett's success is due to his strategy of evaluating companies based on a number of characteristics - value investing. It actually aligns very nicely with Taleb's personal investing strategy (as noted in his later book, the Black Swan) of eliminating uncertainty.

Long story short, the less you know, the more "random" events appear to be. As Taleb wrote, "a surprise for the turkey is not a surprise for the butcher." Buffett's strategy is to know/understand as much as possible. Of course you will still be victim of the unexpected, but probably not as frequently.

A nitpick: Berkshire Hathaway don't publicise any stock purchases or sales and they don't comment on them. Specifically because they don't want to give out information that will drive up the price quickly.

I imagine that's grown harder and harder as time goes on, given the ability of HFT algorithms to spot big purchases in progress. But Buffett has always preferred outright purchases or special one-off deals (eg. the Bank of America deal or individually-negotiated insurance contracts).

Warren buffet buys Goldman Sachs off-market for a 20% discount during the GFC. It's not the first time he's been given a very large return because he's warren. Comparing returns including that kind of thing to what you and I can get buying at market prices on a stock exchange is absurd.

His returns come from management giving him their shareholders wealth as much as anything and have done for some time. Someone will now claim he was righteous and a white knight saving salomon's management or saving goldman's from gfc ruin or whatever. Believe that if you like but don't compare it to those who were shut out from making that same buy at the same time and same price. I'd be surprised if in the past 20 years or so if you factored out all the off-market, warren only buys he got if his returns didn't look a lot more like the S&P500 adjusted for statistical risk using standard CAPM beta measures.

Saying so out loud will offend the hell out of a lot of people who really need to believe. But maybe someone will calmly and dispassionately do the calculations and show my suspicion to be wrong.

That coin flipping analogy is not comparable to active trading. I'm going to paste a comment I made on this topic less than a month ago: https://news.ycombinator.com/item?id=13303395

In addition to the comment pasted below, others in this thread have shown that the actual odds of someone consistently beating the market for decades becomes 1 in billions or even trillions. Yes, there are very few traders and funds that consistently beat the market, but there are enough that it seems implausible to be due to chance when you do any reasonable math. You would need nearly the entire human population trying and failing at beating the market in order to justify the number of demonstrable winners we can observe as mere chance. It's much simpler to assume that 1) market inefficiencies exist and 2) some individuals have the technical skill, domain knowledge and/or business acumen to repeatedly capitalize on them.

I don't understand why this coin flipping analogy from efficient market hypothesis keeps popping up. We can clearly see that funds like RenTec exist, and average 70% returns year over year for literally decades. It's an attractive idea, but I've never seen anyone who puts it forward do any empirical calculation. The claim is essentially, "Get enough monkeys slinging poop in a room full of typewriters and you'll eventually get Hamlet." If you want to cast doubt on the fundamental possibility of people beating the market, at least least try to claim that these successful funds/traders illegally trade on insider information. Don't use the same analogy that is basically indefensible under real scrutiny.

Comment below:


Yes, that's the classical coin flipping example from the strong position on Fama's Efficient Market Hypothesis. There are several problems with the coin-flipping analogy:

1. As stated, it's not falsifiable. So you start with a conception of the market as entirely random, and you observe that participants are consistently beating this market. Each time you observe someone beating the market, you chalk it up to the probability distribution. "Well, that's just a two-sigma event." Then you see it happen again. "Well, that's just a three-sigma event." Then again, and again, and again. How many sigmas from the average market performance are you willing to accept before you agree that someone is legitimately and purposely beating the market with a skill-based mechanism, not a chance-based mechanism? Furthermore, do you have the numbers to turn this into a falsifiable claim? What is your time interval? Daily, weekly, monthly or annually? How many correct forecasts do they have to make ("how many sigmas from the average"), compared to the chance expectation of coin flipping over the same timescale? If you don't have these numbers handy, then it's purely a thought experiment. Subsequently, the observation that funds like Berkshire Hathaway, Bridgewater, Renaissance Technologies, Baupost Group, Citadel, DE Shaw, etc. consistently beat the market for at least 20% net of fees over 20-30 years suggests that, per Occam's Razor, people can beat the market due to skill.

2. The analogy is not comparable to active trading. You don't need to hit 20 heads in a row to beat the market consistently, you just need to hit a p-value number of x heads correct for y coin flips greater than chance would suggest. We don't assume that basketball is a game of chance if the players can't make all their shots in a row; nor do we assume that baseball players with a 0.3 batting average aren't clearly better than the average high school dugout. If your trading interval is weekly or monthly, and you're consistently up over the market (even net of fees!) for 240 months or 360 months, it doesn't matter if every single month was a winner.

3. Have you ever read Warren Buffet's response to the EMH assertion, as postulated by Fama?[1] He outlined an excellent rebuttal in his 1984 The Superinvestors of Graham and Doddsville. Essentially, if you assume that the coin flipping analogy does map to trading, then you should expect to see a normal distribution of the winners, given that the market is inherently random and no one is achieving superior coin flips through skill. However, if you observe that the winning coin-flippers consistently hail from a small village with standard coin-flipping training, then it is more reasonable to assume that there is something unique about those particular flippers. This is what we see in reality - yes, most amateur traders fail miserably, and yes, most hedge funds underperform the market over time. But there is a relatively small concentration of extremely successful funds and traders in an uneven distribution.

4. Even Fama has walked back on Efficient Market Hypothesis, and no longer espouses the view that the market is inherently random. It is deeply complex, yes, but it is not efficient, nor entirely random. Several studies have been conducted to empirically examine EMH, and the results in favor of the hypothesis are dubious.[2][3][4] A much more charitable retelling of EMH is the weak position, which essentially states that any obvious alpha will be quickly arb'd out of real utility, but that non-obvious alpha, or alpha which is technically public but not easily accessible will retain utility until it becomes obvious. This also maps more cleanly to reality, in which trading on e.g. news reports is mostly unprofitable (everyone can get a news report at around the same time, for the same level of skill) whereas mathematically modeling pricing relationships can be extremely profitable (doing so accurately requires public, but mostly unclean data and a great deal of skill). _______________________________________ 1. The Superinvestors of Graham and Doddsville - http://www8.gsb.columbia.edu/rtfiles/cbs/hermes/Buffett1984..... 2. Investment Performance of Common Stocks in Relation to Their Price-Earning Ratios: A Test of the Efficient Market Hypothesis - http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.1977..... 3. The Cross-Section of Expected Stock Returns - http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.1992..... 4. International Stock Market Efficiency and Integration: A Study of 18 Nations - http://onlinelibrary.wiley.com/doi/10.1111/1468-5957.00134/a....

The dissonance is strong with this one. I have tried multitude of times to explain that trading is not throwing dice. When you throw dice, you get a final outcome. When you open a trade you get a stream of outcome (which is not 0 or 1) and you are free to select the current outcome (close a position).

In its lifetime, your position is going to swing from negative to positive to negative multiple times. Emotions and naivety makes novice traders lose money on their trades while luck make throwing dice a random event.

In my opinion, people are just afraid to admit that someone else has a bigger dick (or tits) than him(or her).

One in billions is not impossibly rare when there are over 7 billion humans alive.

The ratios for these calculations only include participants. There are seven billion humans, the vast majority of whom are either not old enough to trade or not in regions where they can actually participate in trading (in the speculative, not investing sense). Of those even eligible to trade, most do not engage in it in any kind of intentional capacity, let alone professional.

There are not seven billion traders. At any time in the United States the number of funds is in the thousands. Adding in other countries, and being generous with the term "trader" (or "investor", "fund manager", etc), I would be willing to agree that there have been millions over the past two decades (the same time frame as some of the track records I've mentioned). What does that leave us with? We're still orders of magnitude away from the successes we observe emerging due to chance. The numbers just aren't there.

I'm not a stats or even econ nerd, but could the numbers shake out if you counted all of the participants since the market was created?

Hm...theoretically? The thing is, the broad zeitgeist of extremely profitable strategies changes over time. James Simons and Warren Buffett might as well be in different fields for how different their day to day work and peripheral market behavior were during their careers. That might be confounding, because on a long enough timeline all job functions become obsolete and have to change.

Other than that though, sure. Unfortunately it would be really difficult to examine empirically, which is why I use a 20-30 year slice of time.

For Buffet's take on this argument, see https://en.m.wikipedia.org/wiki/The_Superinvestors_of_Graham...

"If you have enough people throwing coins"

How many people do you need for a "Buffett or better" event to have > 5% probability of happening?

If you consider that there is a chance a flip will give you another hundred flips for free... And that can compound. It probably isn't as unlikely as you think.

There is a good Euler problem on investing showing that odds based investing can be relatively easy. Of course, many things including granularity of bets, floors, ceilings, and fees complicate matters considerably.

But, a relatively few big wins can give you a lot of slack.

Is this the one?


Interesting, I might have a go at it this afternoon.

It is, thanks for looking it up!

Funny, I went and clicked it. Turns out I solved this 3 years ago and had no recollection :)

If I misrepresented it, please correct me!

"showing that odds based investing can be relatively easy"

It depends on what you mean by easy. To maximize the probability of going from $1 -> $1B in 1000 flips, you need to bet almost everything you have every time (the answer to the problem is > 0.99999).

If you do so, you must win at least 917 of the coin flips to get more than $1B. I can't compute the probability of this event, but using the normal approximation to the binomial distribution, the probability of winning at least 615 coin flips is less than 1 in a trillion (10e-12). You can imagine how much lower it is if you need 917 flips.

This is under the favorable betting scenario where you get 2x the value of your bet every time you win.

EDIT: Ignore everything above. Clearly I solved this a while ago and forgot to check what the actual question was. The probability that you become a billionaire is > 0.99999, the optimal fraction is quite small, of course.

Things change drastically if you get the value of your bet when winning instead of 2x (it seems you need 602 coin flips in that case which is about 0.07 in a billion).

That isn't what that answer means, is it? Rather, that is your odds of becoming a billionaire. Which is basically certainly.

Now, yes, that is greatly simplified and lets you always divide your current wealth. And always double. That is what I meant about floors and ceilings.

I recall playing with the code to toy with more realistic situations. Washing fees out of the game makes it a lot easier to not lose everything.

By no means guaranteed. But easier. And it is likely someone could have done really well by the odds.

Edit: Just saw your edit. Yeah, it was easy to think it was asking the other question. And yes, realistic scenarios are vastly different. Otherwise, a lot of us would be billionaires. :). Just pointing out that the odds aren't nil. Just small. And don't forget, in real scenarios you can change games once you have won enough.

It's worth pointing out that Buffet doesn't invalidate the weak efficient market hypothesis (the usual contender), because he generally doesn't like to trade in the open market.

His preferred approach has always been to buy entire companies, usually private companies, outright. Where there is no highly liquid market, there cannot be an efficient market in the theoretical sense. He prefers to invest when it is actually possible to possess information or insights that have not been widely distributed to other potential buyers via public disclosure. There is a similar dynamic at work in real estate, where local knowledge allows outsized returns to some participants.

The main source of free cashflow for Berkshire Hathaway has always been insurance, itself a risk-based industry. His main advantage has been to rigidly underwrite for profit, not for volume, giving access to cheap float.

None of these things are easily duplicated by regular folks and their advantage diminishes sharply with scale, as Buffett himself has warned Berkshire Hathaway shareholders for year after year.

I admire him and I think he's a useful foil to purely statistical views. But I also think luck plays its part. He's flubbed billions of dollars on both foreseeable (textiles) and less foreseeable (airlines) events.

Yea, he built an amazing track record well before he started to buying businesses outright (and in dollar volume he's spent far more on public companies than private). His preference for buying companies instead of shares only came around later in his career, and solely due to the massive size of his portfolio that his success created.

He didn't get into insurance until about 20 years after he started investing. His greatest returns were before it.

Buffett/Graham believe in concentrated portfolio, not having too many positions in your portfolio, because if you have more than 20 or so positions its difficult to know any of them well. So this means when his portfolio grew in size, he started losing opportunities in the public markets because many companies were too small for him to buy enough of to have a reasonable position. So he ended up investing in larger cap companies, and buying smaller cap companies outright.

And his biggest flub wasn't textiles or airlines, it was maintaining Berkshire Hathaway as his investment vehicle. He gives a free ride (no fees) to investors on half his results, and because of the double portfolio size restricting his investment options, his returns are lower. He would have had a substantially higher returns if he just invested his own money, or if he had kept running an investment partnership and taking fees. He's cost himself at least $100B in personal wealth.

But despite his very infrequent mistakes, he's beat the market by well over 10% a year during his investment career, and there is almost no luck in that.

> Yea, he built an amazing track record well before he started to buying businesses outright

He himself has said that the easy days are long over. The actual stock market continues to form a closer and closer approximation of weak EMH.

> But despite his very infrequent mistakes, he's beat the market by well over 10% a year during his investment career, and there is almost no luck in that.

He beat the stock market, by and large, by not participating in it.

Owning insurance companies and buying companies outright is not a strategy I can pursue with my 401(k).

I like Warren Buffett. I've read the first 50 Berkshire Hathaway letters. I think both he and EMH proponents are "correct", but largely they talk past each other. Where they agree is that what works for Warren Buffett only really works for Warren Buffett. His literal advice to regular investors is to buy index funds.

I somewhat agree with you, but I don't think the market is necessarily converging to weak EMH. I think it's more fair to say that as the market changes over time, the skills required to reliably beat the market fundamentally change. It used to be that you could spot market inefficiencies with an MBA and a solid understanding of specific domains. Nowadays, you model the market as a physical system and look for obscure phenomenon.

On the one hand that sounds like what you're saying - the market is becoming more efficient. On the other hand, I propose that there is no evidence the market will become more efficient continually, and the new normal is due to the rise of software eating the industry.

I agree with you and disagree with other posters here.

It's physically impossible for the market to be efficient.*

Just try to use the efficiency for anything (set up any series of steps where one of the steps is "...because the market is efficient, therefore...") and whatever you've just set up just plain won't work.

Since it's impossible, instead of any version of the efficient market hypothesis people should just say "God's will" (as in God's will that prices should reflect available information), and it will show how silly they are.

* you can email me if you'd like a rigorous proof that it is impossible

It depends on what you mean by "efficient".

The weak EMH is pretty simple: there's money to be made in arbitrage, but the act of arbitrage spreads information. So a price quickly converges to reflect available information. The harder participants try to beat the market, the harder it becomes.

What's left is the lurch of prices upon truly novel information arriving. Stocks appear to move up and down at random, because future events are not fully predictable. If they were, prices would stabilise around the "true" price and remain stuck there.

A similar argument has been used to show that time travel has not and will never be invented. Arbitrage across time would be even more profitable than arbitrage across space.

> On the other hand, I propose that there is no evidence the market will become more efficient continually, and the new normal is due to the rise of software eating the industry.

Could you elaborate? I'm not sure I follow.

Sorry, I guess I wasn't clear. What I meant was that while finding alpha has indeed gotten harder over the past several decades, there are different candidate hypotheses to explore what will happen in the future. I interpreted your comment as a hypothesis that the market will continue to become more efficient as it essentially achieves weak EMH. However, I believe that you could consider the hyper-efficiency of recent times to be a natural byproduct of software and automation becoming ubiquitous.

Information gets cheaper, faster and more accessible over time but I believe that there's a diminishing return in how much more efficient the market can get without another huge jump in technology.

For example, HFT (specifically, the sort where you're actually thinking about the speed of light) is not categorically improving dramatically year after year anymore. The market is getting more efficient, sure, but it's getting more efficient very slowly, and would argue the rate of efficiency increases is decreasing. Without another categorical jump in technology (e.g. significant AI, quantum computing, etc) that dramatically improves data cleanliness or accessibility, I don't see the market getting significantly more efficient than it is now. And I don't agree that the market is yet at weak EMH.

Yeah, Buffet is actually not the best case to back up this argument with. RenTech/Jim Simons [0] is probably a better example of making money on pure skill.

[0] https://en.wikipedia.org/wiki/Renaissance_Technologies

The argument here suggests that there may be choices to make that guarantee LOSS, not success. In that case, learning how to avoid the 'automatic loses' is important and the more people that learn it, the closer things revert to the power-law distribution.

I see no reason to conclude the hyper-winners are more than just luck. Perhaps all the '1% edge' associated with talent is simply avoiding bad mistakes that always deliver a loss. If everyone performs optimally, it becomes entirely and completely luck.

> ... If everyone performs optimally...

I guess it's a lucky thing that'll never happen? I seriously think the only skill involved in investing is a combination of humility and an admission that you're not smarter than everyone else. It keeps you medium conservative and provides solid returns.

It's impossible to empirically examine whether or not humility and reverse-Dunning-Krueger is important for trading acumen. On the other hand, it's demonstrable that domain knowledge and business acumen, or mathematically modeled market signals and statistical insight can result in reliably superlative returns.


"We find that the secret to Buffett’s success is his preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative drawdowns this entails. Indeed, we find that stocks with the characteristics favored by Buffett have done well in general, that Buffett applies about 1.6-to-1 leverage financed partly using insurance float with a low financing rate, and that leveraging safe stocks can largely explain Buffett’s performance."


This paper only starts in 1976, so it skips the first 20 years of Buffett's career when he used virtually no leverage and had his highest returns.

It also has problems with the classifications of his investments. It's a common problem for academic analysis of investing, if value investing works then I should be able to outperform solely buy purchasing stocks at low PE ratios, right? This doesn't work, so value investing "can't" work.

The truth is it's a skill. You have to be able to find businesses with long term competitive advantages selling at a substantial discount to their intrinsic value. You have to have the courage of your conviction through market cycles and not abandon your purchases even cheaper. You have to eliminate sources of bias in your analysis (Buffett won't look at it's price before he analyses a business so his valuation isn't affected). If you read Buffett there are a ton of things he does to limit bias in his job.

None of this can be academically measured.

This is well covered by Charles Ellis: The stock market has changed dramatically since the 70s, when most money was invested with almost no information. Getting key information well ahead of the market was relatively easy. A lot of people made a lot of money then, until the amount of 'smart' money rapidly increased.

It's still possible to get better returns than average on the market: After all, most of congress does this. But the one way to do it is precisely like congress does, by having information that the market is unaware of.

This is what make people move money into venture capital: It's a way to invest into things most of the market is unaware of, and whee the number of players is small enough that it's still possible to get privileged information.

Buffet's current plan is only doable because he has access to more information, and has such a gigantic bundle of money that any effort to get an edge will be multiplies by investment size.

Where does the wealth of the richest people in the world come from? Tremendously risky bets, going heavily into a single, extremely successful venture that they had special access to. But what makes their ventures win, vs those of second players that did badly in the same industry? Non replicable things, distributed in a way you could call luck.

Isn't in general, before the Internet , making money in business was much easier, hence qualititavely different, and maybe skill played a bigger role then ?

Clif Asness is a successful investor. I wouldn't dismiss his findings so easily.

> this paper only starts in 1976

Explaining Buffett's performance since 1976 is an informative exercise.

It is, but it's similar to covering a start-up after their initial hockey stick growth. How to maintain growth is interesting, but definitely not the whole story.

> He prefers to invest when it is actually possible to possess information or insights that have not been widely distributed to other potential buyers via public disclosure.

This is exactly the opposite of what he claims in his essays. One quote:

> The other way we differ from some arbitrage operations is that we participate only in transactions that have been publicly announced. We do not trade on rumors or try to guess takeover candidates. We just read the newspapers, think about a few of the big propositions, and go by our own sense of probabilities.

There are several others in "The Essays of Warren Buffett" where he also describes how he just uses public information.

Again, there is a distinction between buying private businesses outright and buying in the open market.

In the former case, Buffett solicits sellers to directly contact him. He makes this solicitation every year in his letter to Berkshire Hathaway shareholders.

In the latter case, Buffett recommends the Financial Times as a source of information.

Yep. If the market you're competing in is too efficient, find another market.

Buffet doesn't claim it's impossible to beat the market. He only says that the vast majority of investors cannot pick individual investments accurately enough to beat a diversified, low-cost index fund in the long term. There are a bunch of caveats in here, namely LONG TERM – you might get lucky and strike it rich once or twice, but you are very unlikely to have those lucky investments pan out over decades.

Yes, Buffet is incredibly skilled. Buffet actually claimed once that he was born with a preternatural ability to invest in companies. The whole "you can't beat the market" quote is meant more to say that we mere mortals are to Warren Buffet what normal people playing pickup basketball are to Michael Jordan.

If the majority of investors "beat the market" wouldn't that just become the market?

A better way of saying it is that the whole of investors are better at accurately predicting the value of a company than individual investors. Which sounds almost like a truism when you put it in those terms.

Survivorship bias?

Another example is Renaissance Technologies. Their Medallion Fund has averaged 80% returns.

If you put $1,000 in the fund in 1988, it would've become $13.8 million by 2016.

See: https://www.bloomberg.com/news/articles/2016-11-21/how-renai...

It wouldn't, no. Their strategy is limited by size, and they're returning profits (that they can't invest further) to investors every year. I.e. the returns aren't compounding (any longer).

It's even more frequently than every year these days.

Obvious counterpoint: it's statistically "impossible" for Buffett specifically to beat the market in the way he has. Is it similarly impossible for some person to beat the market in the way he has? Let's call this hypothetical individual Warren Buffett.

Read super investors of Graham Doddsville, Buffett wrote it and demonstrated there are dozens of value investors with similar results to him, and they all adopt an extremely similar strategy but apply it in very dissimilar investments.

And the coin flipping paradigm is wrong. The odds of beating the market by 10%+ a year is not a 50-50 proposition. It's more like a 1 in 10 chance. So re-run your stats with Buffett going 50 for 53 on 1 in 10 shots.

It helps if you start investing when technology was a novelty. In the 60s!

Technology is still a novelty. We've barely dipped a toe in the digital age, the vast majority of changes are yet to come. We probably haven't written 1% of the software we'll be using in 20 years.

It's not only statistically impossible for Buffett to be a fluke

I'm curious, do you have any evidence of this? "Statistically impossible" means "zero probability". If that's really your argument then you need to back it up.

Perhaps you mean, "improbable"?

you just confirmed what keeps people from uderstanding this truth: confirmation bias.

you just picked one person out of billions of investors. what is more improbable? that he is flipping a coin 40 times and got head all the time or that billions of people cant see what he sees?

also, buffet is the perfect example of why you should not invest, as he beats the market by not investing in the market.

> what is more improbable? that he is flipping a coin 40 times and got head all the time or that billions of people cant see what he sees?

Actually, the probability of getting a head 40 times is 1/2^40, which is 1 in about 1.1 trillion. If we assume there are 1 billions investors overall, the probability that at least one wins 40 times (which is the probability that one or several Warren Buffet could appear by luck in this simple model) is about 0.00091.

So yeah, in this particular phrasing of the question, with this model, the less likely option is to flip a coin and get head 40 times and the more likely option is that there is something else, like talent.

>>Actually, the probability of getting a head 40 times is 1/2^40, which is 1 in about 1.1 trillion

I bet that the odds of beating the market 40 times are even worse since it is not a simple binary choice. The better analogy would be to choose the correct face of a 6 sided dice 40 times in a row, or even better a 100 sided dice. Calculate the odds for that! (I'm too lazy to do it myself)

hrzn says:"So yeah, in this particular phrasing of the question, with this model, the less likely option is to flip a coin and get head 40 times and the more likely option is that there is something else, like talent."

Before concluding "talent" is responsible, you must exclude other possibilities in the "something else" category (e.g., intelligence, insider information, control of upstream/downstream resources, etc.).

Wealth allows access to resources unavailable to those w/o wealth.

I Absolutely agree. Overall it's probably a mix of many things like luck, talent, insider information, ability to go against dominant investing ideas, where you start in life (if you are wealthy at birth that's equivalent to many coin-flips), etc.

>>You just confirmed what keeps people from understanding this truth: confirmation bias.

It seems a bit hard to believe that this is just confirmation bias. What are the odds that he guesses correctly almost 40 times in a row? It is possible but not likely. If he is not really as good as we think he is then you could also say that he is doing insider trading and he just hasn't been caught.

Honestly I don't buy the theory that he is just extremely lucky.

People winning the lottery (what is it already? 1 chance in 300 millions ?) must be very good at lottery.

Did you not read the other comments in this thread talking about the numbers?

The probability of repeatedly beating the market the way Buffett has done it is several orders of magnitude lower than the probability of winning the lottery. That's the point.

Now win it 40 times in a row.

Not comparable - beating the market one year is quite probable.

Your analogy is a poor comparison. Winning the lottery is not like picking stocks because it's almost perfectly efficient. No player in a lottery has any insight about what the winning numbers will be that, let alone an insight that other players don't have. It's an absolute black box.

I know what you're thinking. "The stock market is a random walk! Efficient market hypothesis!" But the market is not a black box. You can legally gain insight that other participants don't have and use that insight to profit.

Other people have done the math in this thread. The human population would need to be orders of magnitude larger than it is now, and every human would need to be an active, failing market participant, in order for the successful traders we see being the result of chance.

Buffett has always invested in the market. The last half of his career he has made many private investments, but his fortune was built on public stock market investing.

His average returns with the Buffett Partnership were in excess of 35% a year. That's not coin flipping. The odds of a 35% return when the stock market is returning 10% is probably closer to one in a hundred. doing that for a decade straight is insane.

Then follow it with 40+ years where he beat the market every year but a couple, and not barely crushing on average by over 10% year (probably 10-1 against each year), even when handicapped by an enormous portfolio.


> you just confirmed what keeps people from uderstanding this truth: confirmation bias.

More like just world falacy in this case.

It's everywhere in all things social. Some religions even incorporate it (Hinduism, Buddhism and Calvinism come to mind)

Dubious validity?? Participate in the market and try to replicate what you think are dubious counterarguments with achievable and repeatable results.

People like Buffet and Einhorn are extreme anomalies. So much so that they are legendary, they are that unusual. There are only a small handful of legendary investors throughout history for a reason.

"It's not only statistically impossible for Buffett to be a fluke, it's statistically impossible for him not to possess a a skill providing a substantial edge in market investing. Not a "1% a year" type skill."

No. It's statistically impossible for him to be the NORM, or some sort of aspirational figure. Statistics is exactly how we can measure how much of a fluke he is, and how lucky he's been. Give him 2% for ultra-talent, and another 5% for trading on the fact that he's Warren Buffett, and he's still a fluke. He is just able to put a thumb on the scales for personal/emotional reasons: implying to people like you that he's not a fluke. The odds of him being in that position are very long odds, and he lucked out and has taken advantage of it. If you run a lottery and draw one ticket, that's long odds but by definition one person will have won.

And if you give him 10% for ultra-skill? What about 20%?

Statistics tell you he's an outlier. It tells you nothing about why, however.

Okay, and what is the point of statistics as a discipline if you don't use it and make up percentages for arbitrary assessments?

This seems like some form of the lottery fallacy: that because an event occurred (some guy beat the market over a long period of time), it must have been the result of some forces (his skill) overcoming luck.

I'm sure it has been quite a few years since Warren Buffett has made investment decisions on his own. Now he will have quite an intellect behind him.

Not only that, but it fails to consider that many times, a large wealth, is not built with an extra 1% per year, but by one large hit. People have failed 20 years to then become rich on one good idea. You could call it luck, but to be realistic that's not luck, that's perseverance, work ethics and commitment to do something important. I agree we need to look for a way to build a more even play field and remedy the atrocious way we assign resources, but claiming that people that work hard to make a difference are just "lucky" is a terrible way to do it.

It's luck but in the sense of that Seneca quote: "Luck is what happens when preparation meets opportunity"

I don't like those quotes (like 'the harder I work, the luckier I get') because 'luck' by it's very definition is random. We had a horrible situation in Melbourne yesterday where some nutbag drove his car down a busy sidewalk killing 4 people. It was luck (very bad luck) that those people were there in that moment and killed. That's luck. And btw, my partner and kids were there only 5 minutes before.

"How big can this “talent differential” be and still stay statistically consistent with the power law wealth distribution we see in the real world?

It turns out that it can’t be more than about 1 percent.2 A larger talent differential would produce a wealth distribution that is even more extreme than the real one, and that would not follow a power law."

I thought this article looked like it was going to be very obvious, but that passage got my attention. I'm all for experiments of this nature: one day AI will be doing it as a matter of course, on a massive scale.

Lines up with my observation, too: talent makes a difference, and it's about 1% over time. Kind of like compound interest. You can win out if you're very persistent and very determined and you fail a lot, because you're shooting for that 'luck' moment. There's no telling where it will strike, because it's luck! You have to stay in there and not go broke because it's luck, there's very little correlation between merit and success.

I suspect if you went by tenacity rather than 'talent', the number might be a lot more than 1%. But bozos can be tenacious too, which is a daunting thing to consider.

And it's why you see successful bozos as well.

Yup. People dismiss this because they assume the number of tries to be relatively small. But in truth, we're making dozens of decisions every day. Compound that over a career and a 1% advantage adds up to huge potential, for those determined enough to keep trying at it.

Talent prevents you from shooting yourself in the foot, which gets you to breakeven. Luck takes you up from there. Time turns unlikely events into inevitabilities.

> We all know stories of ambitious and talented people like Steve Jobs or Bill Gates, who grew companies and created great wealth.

True. Yet both were extremely lucky at the beginning. We all know the story but Gates' mother knew IBM President John Opel, his father was a prominent contract lawyer, and IBM originally wanted CP/M but Gary Kindall missed the meeting to fly his plane. And Microsoft retaining the rights to the OS was, in hindsight, a very grave mistake.

Jobs had the charisma and drive, but without Woz I'm sure we wouldn't be talking now about Apple.

But given the opportunity that this initial luck gave them, they absolutely maximised it, so good on them.

But they could've still made something of themselves, even if that opportunity didn't pan out? They might not have become billionaires, but I don't think it's unrealistic to assume both would've done well in life.

>If the ratio of 50,000 were to hold for other traits, it would imply individuals who are 53 miles tall, have IQs of 5 million points, and live to be 4 million years old.

That's just not how to do statistics, sorry. First of all, one of those is not like the others: IQ is normalized, the others are not. There are so many assumptions about linearity and distributions here that would need to be a lot more rigorous before anything like this could be said.

See http://www.thedailybeast.com/articles/2013/02/06/department-... for an actual interesting point regarding income and bell curves.

IQ is normalized, but that doesn't change the shape of the distribution. It changes the scale, but not the shape.

I agree there's a lot of details that need to be done to make this more rigorous, and I was hoping that the article would be more thorough.

But this has been on my mind a lot lately.

Basically, most human [behavioral] traits are normally distributed, or something close to it, which is radically different from income distributions. At some point, the shape of an income distribution must become inconsistent with what we know about the shape of human trait distributions and wages under fair labor markets, etc. It should be possible to test whether or not an income distribution is consistent with a given trait and market model, and to compare them statistically.

I appreciate McCardle's writing, and read that in the past, but think it's sort of tangential to the points being raised here. Furthermore, many of her arguments aren't supported by the data. That is, income inequality really exists across a wide range of professions. If anything, I suspect there's some demographic effects involved (for example, older, very well-established individuals with a "lock" in a given labor market, shutting out younger individuals).

They also don't even get into cheating as another factor that's nonrandom and might be construed as a "skill" but is arguably unrelated to "real" market value.

All of this is consistent with arguments that the biggest predictor of returns is length in the market. That is, you're better off putting things in a very diversified index portfolio than anything else.

Someone else mentioned Buffet. Even if things were random, with enough people, you'd still end up with people who look like they're not benefiting randomly.

Anyway, I'm not really trying to question Buffet's investing skill. I'm sure that it's not totally random, but I suspect that there is a big element of randomness also. And income per se is different from investment skill per se.

>IQ is normalized, but that doesn't change the shape of the distribution. It changes the scale, but not the shape.

It means talking about an IQ of 5 million as somehow analogous to linear extrapolations of height or age means the author has no clue what they're talking about. The only way to have an IQ that high is to have a population large enough for it to be meaningful, while the other example are possible statistically (if not physically).

Anyway, having now read through the rest of the article, my critique is much simpler: they're using a simplified model with specific magic constants, and using it to derive exact values for other unknowns (specifically talent).

>Half the time it will come up heads and yield a return of 30 percent, and on the rest of the tosses it will come up tails and yield a loss of 10 percent. The numbers are chosen to give an average annual return of 10 percent, plus or minus 20 percent, which is typical of investments in the real stock market, but the overall conclusions do not depend on these specific numbers.

But then they say

>How big can this “talent differential” be and still stay statistically consistent with the power law wealth distribution we see in the real world?

>It turns out that it can’t be more than about 1 percent.

I haven't dug into the numbers here, but I'm comfortable discounting their conclusion because of the clear signs of unfamiliarity with concepts mentioned, as above. Also, they seem to be assuming that most of these people made their money investing, but that's unrealistic, yet they cite articles about money managers. It may very well be that money managers perform randomly, but that clearly shouldn't extrapolate to other rich people. The whole model is incorrect, people get rich by doing many other things (start a business, invent a product, etc) many (most?) of which are, in fact, related to talent but are completely missed by the model.

They casually throw out the claim that "They cannot possibly be the whole story at the high end, where people’s wealth is primarily determined by capital gains or losses on investments." but with no citation, and, as above, I doubt that. (A quick search turns of up http://www.forbes.com/sites/erincarlyle/2013/09/18/how-self-... which says investing is plurality but not a majority of the top 400's sources of wealth).

They keep on going back to people like Gates and Jobs, further confusing the question.

Even the Steve Jobs example of a super-talented individual relies on luck.

In the universe where he didn't meet Steve Wozniak, Steve Jobs was probably consistently in the top 3 Mercedes salesmen in California.

Not to mention: merely being born in a wealthy country during a period of relative peace is so much luckier than the lot of humans throughout history that it is almost worthy of bad science fiction.

IQ, country, time born, etc are all forms of luck, of course, but it's worth distinguishing that luck from luck of experience that happens later in life.

The difficulty is that we draw the distinction using available examples of successful individuals and companies. This sample is fantastically biased due to survivorship.

Without a complete record of all the failures of equivalent intelligence, drive, experience etc, it's not possible to fairly attribute to luck or to personal characteristics.

Which would be true if wealthy countries in times of peace were randomly distributed rather than being as a result of culture

Wealthy countries are not randomly distributed, but where you are born is randomly distributed, with a bias to the poor side.

You're born in close proximity to your mother. The veil of ignorance is a mental model; in reality, there is no lottery stork that places children randomly.

Culture which the people born into have no affect on prior to being born into them, so what would that change about the point?

It's not like the US has this super peaceful culture either, so I'm not even sure about what culture has to do with it at all. But even if that made perfect sense it would change nothing about the original point.

I am talking at an individual level.

Despite what some folk might wish to believe, Steve Jobs probably came to exist because his parents had sex.

If Wozniak never met Jobs, Woz would just be a super valuable engineer working for some large company. Jobs always would have found someone to build things for him, and would have been a super successful entrepreneur. His product development instincts/ability was off the charts, both in how he motivated people, how he managed the process, and how he created end goals.

Woz built the Apple I by himself.

Without Woz, I'm not sure what Steve Jobs would have done. Probably nothing important. Steve Jobs was definitely a very talented man, but he was also in the right place at the right time.

If Apple didn't exist, we would still have computers and laptops. We would still have smartphones in 2017. I think everyone would just be using Android (or something similar), and no-one would know what they were missing.

"Without Woz, I'm not sure what Steve Jobs would have done. Probably nothing important"

Do you think that Woz is unique?

That Jobs wouldn't have found another tech guy to build some other whiz-bang thing with him?

No, I just think the whole situation is very unique. Jobs wasn't really looking for a tech guy from the very beginning. He was introduced to Woz and they ended up building something together. So he stumbled into it, just like any entrepreneur stumbles into their ideas. There's also nothing particularly special about the founders of Dropbox, Google, Amazon, Microsoft, or Facebook. These were all built by smart hard-working people, but they just happened to have the right idea at the right time. I don't think Jobs and Woz are any different.

This is all just conjecture, and there's no way of knowing what Steve Jobs would have done if his life had been slightly different. We know that he founded NeXT Computer after leaving Apple, but it's hard to imagine him founding that company if he was never involved with computers.

The pool of Wozniakian engineers is limited. And it used to be very, very limited.

If it wasn't Jobs, it'd be someone else, and we'd be just as sure that the other ubermensch was Destined To Succeed No Matter What.

Wozniak had nothing to do with the success of the Macintosh, iPod, iPhone, and iPad, or the NeXT OS that runs on them. Steve Jobs was successful with Woz, he was successful without Woz, he was successful when handed a near bankrupt Apple and forced to turn it around. He was even ultimately successful with NeXT, despite a few bone headed decisions.

These are not events with independent probability. Without Wozniak, there was no Apple.

Jobs had a clear entrepreneurial bent and desire to build technological products. He would have found another engineer and likely his first company is not quite as successful, but very likely the rest of his life isn't much different.

BTW: The Mac motherboard was designed by Burrell Smith, who was pulled out of Apples service department, later when on to found Radius. Woz was an amazing engineer but Jobs had a knack for finding amazing engineers and getting them to build his ideas.

Burrell Smith was pulled out of Apple's service department by Bill Atkinson, not Steve Jobs.

The richest eight people now have the same wealth as the poorest 50 percent. Most of that wealth comes from investing (rather than labor). There is no probability model that would lead to this result; eventually someone on a "hot streak" is bound to lose.

What we're seeing is that luck may give some random people a boost at first, but that boost is sufficient to let them take all the winnings over time. The rich get richer. Investing success and wealth building follow a Darwinian rather than a probabilistic model.

I'm not sure I follow. A basic Pareto distribution could easily lead to this setup.

Now, are we seeing that the powers that be are finding ways to keep their wealth? Almost certainly. But, consider that the same fact for "top 8 have as much as bottom half" was probably true in the Rockefeller years. Difference is that, in American until recently, we had schemes to prevent a landed gentry, or class based society.

But to claim that this is somehow new or unheralded in history seems to ignore a lot of history.

Yes, and just once you get big using good luck like Amazon or Facebook, you invest your profits to hire the best people to make sure that no one else can threaten your empire in the foreseeable future.

Gates, slim, Ellison, the Kochs, and the Waltons were all in the top eight from a quick search I did. None of those gained the majority of their wealth through investing.

Buffet and Carlos Slim did, did they not? After starting out in trading (for ~30 years, no?), Carlos Slim got bigger with Telmex (while I don't know how much collusion was involved with that; I assume it couldn't have been none, which probably isn't fair of me) before going large with investing again...

The rest of the list includes Ingvar Kamprad, Bezos, Zuckerberg and Amancia Ortega, and none of them gained the majority of their wealth through inheritance or investment either. Now, their kids on the other hand... :-)

That statistic from Oxfam is really dodgy, if all you have to your name is a dollar bill in your pocket then there are 2 billion people in the world poorer than you, ie they have debt. It says nothing about income.

This article deliberately confuses normal distribution, which applies to such things as height or IQ, and power law distribution, which applies to wealth, social connections, city sizes etc.

I think nobody is surprised about the fact that the largest cities are more than million times larger than the smallest settlements. Or that that top 1% of the largest cities includes the sizable proportion of human population.

There is a book where monkey throws darts at a dartboard beats professional investors. There is also a similar where cats pick stocks with their whiskers and beats the pros.

A Random Walk down Wall Street http://www.forbes.com/sites/rickferri/2012/12/20/any-monkey-... http://www.marketriders.com/investing/why-googles-investment...

Interesting article, but like many things I've read on this topic, it still focuses on the "cause" being luck. I'm not so sure that's correct (not convinced it's wrong, either, but hey...)

For instance, if I look at Zuckerberg or Gates, they had access to an amazing network (happened to both be at Harvard). That network allowed good ideas to explode in value. If Zuckerberg were at a community college in a poor section of the country, I'm not sure his idea would have captured the same value. Similarly, had Gates' mother not been on several boards, Microsoft would never have gone anywhere (clearly the introduction to high-level IBM executives through her board connections was paramount in his success).

I don't discount luck - I think it's very important. But luck comes about from your surroundings, and having access to a network like these two had will tilt the luck in your favor much more than if you have a weak network.

If economists focus on the networks, they will have better solutions to addressing inequality.

One final note - I don't think inequality is necessarily bad - rather, it is the inability to move up (or not evening having the chance to move up) that is the real problem.

Although I completely agree that luck is a major factor, the author loses me when he takes his hypothetical "lucky people get 30% gain, unlucky people get 10% loss" and builds on top of that as if it was a provable fact. It is okay to use this as a mechanism to illustrate that this matches the power law distribution that we see in reality. This part makes sense as an intellectual exercise.

Applying 1% on top of that as talent and rerunning it, stayed within power law distribution but making talent larger would break it. The faulty logic to me is what makes the "lucky 30% gain, unlucky 10% loss" fact? It seems much more likely that there is an 8% base (index funds, e.g.) with luck playing a +-10% and talent being another ~7% (as a hypothesis). Also, remember his "game" to prove luck > talent only ran for 20 years. I'm curious if I plugged this into a spreadsheet and ran for 50 years if I couldn't get the same power law distribution with greatly different factors. Mainly, it requires a lot of luck AND talent.

Do the rich really keep getting richer? I would assume that as you have more money you don't just have more opportunity but also more competition. There are lots of people who try to take your money one way or another without any return.

>Do the rich really keep getting richer?

Yes, that's basically the findings of Thomas Pikkety. His tome "Capital in the 21st century" goes through great lengths to find and explain the numbers behind the finding.

Done now with Pikkety. Well, he summarizes it very simplified. I think his model doesn't necessarily mean that the person who was rich 10 years ago is richer now. It still works out if for example each year a start-up of the same size has a 5% bigger exit than the year before, but 10 years later the founder of the first exist is broke and homeless already. What I mean is it doesn't, afaik, consider fluctuation in each group. Also many economists criticise that money is only measurment of wealth, and some are quite hard to represent in $.

This article represents a disingenuous premise.

It's also grossly mis-titiled.

'Wealth' is mostly not generated by speculative investing.

And yes - most 'investing' is luck, but investors already know that.

But declare that some kid who worked his pants off through school, got into a half-decent Uni, and went on to get a high paying job - to his brother, who didn't do much in school, and took a job at their fathers auto-shop earning a respectable but relatively small salary - in terms of 'luck' is just unfair.

Among the 1% there exists multiple deep and consistent insider networks where stock tips and wealth creation ideas are exchanged. So the 1% crowd thrives from being in that position.

I doubt the top 1% got rich by insider trading.

"I doubt the top 1% got rich by insider trading."

First - there is tons of 'insider trading' going on. It's easy to do, and hard to prove.

Second - though maybe not 'insider' in the illegal sense - but once you have a lot of wealth, you have access to information and systems that others do not.

Warren Buffet made huge bank of a loan to Goldman during the crises. He was one of the few to have the cash and the reputation. Buffet can take advantage of so many situations that very few others can. So that's a lot of leverage.

I'm not saying anything against them, but big finance is an 'insiders game'.

People have been bullshitting us for centuries that market investing is a game of skill. If it really comes down to luck then it is gambling, and it should be treated (legally) as such.

Right. And because of luck you always have the same poker players winning at tournaments, taking home the cash?

I personally don't believe investing in the market is gambling, but even if it were, that doesn't necessarily mean you can't consistently make money from it. Some of it is luck, some of it skill.

Investing in general is about probability. An example: I am working on a deal right now.

If it goes through I put $100k at risk by investing in an asset. Absolute worst case I can resell that asset for $50k, but I can probably sell it on for $100k. Best case if everything pans out I make $3m. The chance of that happening is probably around 50%. Those are odds I like. Lots of upside, almost no downside. Some publicly traded stocks are like that.

Well, some argue that poker is a game of skill. Bluffing, looking for tells etc. Everything I've read is that when you get to the championship level, everyone already is good at understanding probabilities. It's psychology that makes the difference.

In fact, just last night I talked to a woman who does really well at poker because she randomly pretends to be a "dumb broad" on some hands.

Making 30x on investment, with the risk of losing half of it in worst case scenario, sounds like an incredibly good deal.

>> Some publicly traded stocks are like that.

Can you please give an example?

But even if investing is about luck it is still not comparable. Investing was originally (well ... kind of.. ) people betting on which ships would come back from the new world. And it were only those bets that made the game possible, established a new market and caused enormous changes in the world.

Investing is not people playing some made up game - but people playing a heavily complicated game which is also known as: the real world. This makes it fundamentally different. Even if it might be very much based on luck, I would bet on the ship with the more experienced sailor/better crew etc. and would not call that gambling.

One of the best 'Talks at Google' via Michael Mauboussin "The Success Equation: Untangling Skill and Luck"

Thesis: where absolute talent/skill is high, variance in relative talent is low, thus luck > skill.


It certainly needs considerable amount of luck to earn the first big $ on your investments, but you should be ruthless, sociopath, cold blooded, patient and hard-working to continue growing & become like Icahn or Buffet.

The cold-bloodedness just helps justify oneself. It won't change outcomes.

Maybe "insider trading" is often rebranded as "luck".

At least with investing you can spread your risk. In contrast, if you are a programmer at a startup, you typically have all your eggs in one basket. In other words, more talent than luck.

If you can't optimize for talent, you should optimize for costs. Investing in low cost passive index funds is best for most people's low risk plans (retirement, house, etc).

Dubious article relying on Gell-Mann Amnesia.

We'd easily spot the fallacy if it read "engineering correct software Is More Luck Than Talent"

There is no investment. There is only speculation. Speculation that the asset price will increase. Speculation that your purchase will return higher value in the future. In order to be successful at speculation you do have to have certain talents and character traits. Study most successful speculators of or times and you will see certain patterns and common traits.

Speculation is the purchase of investments where you don't have a clear idea of the value of the investment, and are gambling on the direction of the market price.

Actual investment is usually called "value investing", you purchase assets at a substantial discount to their intrinsic value and wait for the market to recognize that value. True value investing is rarely practiced on Wall Street because Wall Street is mostly about the latest fad and charging fat fees to the uninformed. And when Wall Street firms tout themselves as "Value" they are typically just buying low PE stocks, which isn't actual value investing at all.

You should quote your sources. These are ideas from Ben Graham.

You have to quote your sources for the concept of "value investing"? Did I miss a joke?

"value investing" gets thrown around a lot without proper attribution. It's a very specific investment style proposed by Ben Graham. The reason why I like attribution is a) I know that it's the specific thing being talked about b) It gives credit to the originator of the ideas ( especially in the investing circles) since investing is an area where a lot of charlatans like to take advantage of gullible people by looking smart.

I think the terms used above are now pretty well known to those who know something about investing. While it might add information to include their names, I'm not sure if attributing Ben Graham and David Dodd are necessary at this point.

> the terms used above are now pretty well known to those who know something about investing

The speculation-investing definitions where "investing" is defined as "value investing" is specific to the Graham-Dodd school of thought. These are not generally-accepted economic definitions. For example, Index investing isn't "investing" per Graham-Dodd.

    > Study most successful speculators of or times and 
    > you will see certain patterns and common traits.
Most of the traits that come to my mind are unflattering. The chance of making money by legal means is far lower than by insider trading, or market manipulation.

Maybe in speculation, but Buffett is the most successful investor of all time and his honesty is pretty much unquestionable.

> but Buffett is the most successful investor of all time

Last I checked, Renaissance Technologies and Vista Equity Partners outperform Buffett. RenTech is the opposite of a value investor and Vista does technology LBOs.

The exact opposite to Buffet (value investor) is probably Carl Icahn (speculator). Granted, Icahn has had some major fuckups along the way, probably more than buffet, but he invested well over the years. But both operate in a different way. Soros is another.

There's no one way to invest -- you have to find a way that works for you.

I don't know enough about Warren Buffett to emphatically hold an opinion either way. I agree his public persona and life story (or myth, I honestly don't know) reflect well upon him, but "unquestionable" is a strong statement.

Having said that, I agree my comment was a bit hyperbolic. The truth is probably a bit less bleak.

That's not true in the long term. For example if you buy a house and then rent it, you will eventually earn back the cost of buying it, unless there is some kind of disaster in the market. Stocks are really no different.

The quality of tenant is also somewhat based in luck. If they are a pain in the ass then the time lost may outweigh the cash gained.


This account has been using this site primarily for political or ideological purposes, and that's not what it's for. Please don't continue on like this.

Given that certain opinions are very unpopular around here, why should I be forced to use my primary account to post on political topics?

If you look through the comment history of this account, I think you'll find that the posts are all very civil.

When you go to the casino and put $100K on red on the roulette that's speculation. When you use the $100K to go to college and get an engineering degree that's an investment.

There's no guarantee your investment will yield a reward but there's a better probability than gambling (let's just say better than 50/50 for that matter). An investment is putting money towards something that has a good probability of yielding a return, be it your education, renovating your house, a new car, shares in Coca Cola, or US government bonds.

This is getting into semantics, but:

Nothing about investing in stocks is speculation, at least in the theoretical sense. Businesses earn profits. If you buy shares in a business, you are entitled to a share of those profits. Obviously, this gains you money, and this money will (usually) not come at the cost of the business. So, you'll gain money due to dividends, and your investment won't lose money.

Investing in stocks is going to be, on average, a net gain for you. In theory. And mostly in practice, see for example the massive exponential gains in the S&P 500.

There's a lot more to things. For example, sometimes businesses fail and you'll have lost all your money. And on the flip side, maybe a business will grow enormously. But this just adds noise to the data, it doesn't change the fact that, on average, you should make money on stocks in the long-term.

If you just buy a total market index fund, you're making a bet with a high expected value. That's not "speculation" in the same sense of going to a casino and playing blackjack or buying an asset which has no fundamental reason to rise in value (like precious metals).

So, I think it's misleading to call investing "speculation". It gives off the wrong vibes, since the way most people understand the word it makes it sounds like investing is super risky. (And yes, there's some risk, don't get me wrong, but not in the sense that it's a coin flip like many people think.)

Short term equity is speculation. Long term equity is more of an investment.

I think bonds are considered investment although to the price sell them before term fluctuates.

> ...and you will see certain patterns and common traits.


There absolutely is investment, consider the rise of socially-motivated ETFs. You can buy an index in:

  - green power ($ICLN)
  - smallcap biotech ($PSCH) (admittedly this is also used for speculation)
  - boardroom diversity ($SHE)
  - LGBT workforce ($EQLT)

Don't firms like Renaissance and Virtu destroy this notion?

I assume you're referring to the Virtu statement that they only lost money on one day?

That's true (or nearly true) of good HFT shops in general. The type of trading that HFTs do (market making, short term predictions) is generally less risky than long term investments. Also, the risk/reward of this trading is realized over minutes, not over weeks/years. So just as a hedge fund might have an unprofitable week but a good year, an HFT has a bad 20 minutes but over the whole day comes out on top.

For Renaissance, maybe they are truly smarter than the rest of the market or at least able to act on good trades before anyone else. I wouldn't discount foul play though.

I'd really be interested to know about the foul play angle, but firms like these buy drone and satellite data, surely they have some information advantage?

Well, the thing is that other extremely good firms buy drone and satellite data, and other firms also pay the top rate to extremely good people, and etc.

So either RenTech is somehow consistently wildly smarter than the rest of the industry through some completely unknown secret, or something else is up. They might be using insider information, they might have a deal with someone news firms* to get news early, they might use illegal order execution techniques. There's a whole slew of things they might be doing to get an advantage. Maybe they use funds other than Medallion (the super good one) as a testbed for strategies and deploy the really good ones to their best fund. FWIW, I don't think funds started by anybody who left there are as successful so the secrets aren't leaving.

* A friend of mine in the hft industry told an interesting story to me. A high-speed news wire was very predictive of when orders relevant to the news would get run over - except backwards in time. The news was consistently a few minutes late. So either the high-speed news wire was laughably worse than the competition or somebody was getting news early through illicit means.

One could make the argument that their use of basket options was not uncontroversial.

HFTs like Virtu are just front-running, scamming retail investors like you and I out of pennies on every trade. There's no trading or investing happening here, just arbitraging broken market rules. HFTs don't destroy the notion set forth in the featured article because they aren't involved in the same game.

> HFTs like Virtu are just front-running, scamming retail investors like you and I out of pennies on every trade. There's no trading or investing happening here, just arbitraging broken market rules.

Do you happen to have a reference for this? This does not seem to match my personal observations, but I could be missing something.

Flash Boys by Michael Lewis is a good place to start.

It's interesting you say that because the only group most agree is helped by HFT is retail investors, because you are getting a much better price on trades and aren't moving the market.

Edit: If you want a high level overview, there's this article: https://origin-www.bloombergview.com/articles/2016-02-25/-fl...

Or just go find spread sizes in say 1990 or 1995, notice that they are far larger.

Edit 2: Also, HFTs can't see your orders before they hit the market, despite what everyone seems to think after reading flash boys. And the idea that HFTs mostly do latency arbitrage is flat out wrong as well.

> Also, HFTs can't see your orders before they hit the market, despite what everyone seems to think after reading flash boys. And the idea that HFTs mostly do arbitrage is flat out wrong as well.

Not true: https://www.sec.gov/news/pressrelease/2015-164.html

You do realize that this is actual frontrunning, as in a broker frontrunning its clients, and not arbitrage on the market or an HFT getting a sneak peak at the order feed from say NYSE?

Also, this is a dark pool literally operated by an HFT - I'm referring to the lit market under SEC regulation. This pool isn't even available to retail traders, not to say that excuses frontrunning. Their punishment was fairly light as well, unfortunately.

Edit: It looks like ITG is a tech provider that illicitly used info from the dark pool to run a trading desk. If you look at their disclosures on prop trading, it seems their trading was minor and linked to their frontrunning operation. I think most if not all of the prop trading they do is shut down.

I've also edited my parent post to be more clear.

Here's another one from just last week: https://www.sec.gov/news/pressrelease/2017-11.html That doesn't explicitly mention frontrunning but it's guaranteed that's what they were doing. These guys aren't dumb.

By "arbitrating broken market rules" I meant that these HFT firms are exploiting our dysfunctional market system at no risk to themselves (like Virtu's single-day loss in a 6 year period). They engage in things like quote stuffing which incidentally increases volatility, decreases liquidity and leads to higher trading costs.

For quote stuffing in particular the SEC investigated and decided to do nothing. The SEC is fully incompetent as the ITG and Citadel slap-on-the-wrist fines for outright illegal activity further demonstrate.

My point about HFT firms being frontrunning scams is basically true.

Luck is when preparation meets opportunity.

"I'm a great believer in luck, and I find the harder I work the more I have of it" --Thomas Jefferson

Here's Warren Buffett's response, published on May 17, 1984[1]:

"I would like you to imagine a national coin-flipping contest. Let’s assume we get 225 million Americans up tomorrow morning and we ask them all to wager a dollar. They go out in the morning at sunrise, and they all call the flip of a coin. If they call correctly, they win a dollar from those who called wrong. Each day the losers drop out, and on the subsequent day the stakes build as all previous winnings are put on the line. After ten flips on ten mornings, there will be approximately 220,000 people in the United States who have correctly called ten flips in a row. They each will have won a little over $1,000.

Now this group will probably start getting a little puffed up about this, human nature being what it is. They may try to be modest, but at cocktail parties they will occasionally admit to attractive members of the opposite sex what their technique is, and what marvelous insights they bring to the field of flipping.

Assuming that the winners are getting the appropriate rewards from the losers, in another ten days we will have 215 people who have successfully called their coin flips 20 times in a row and who, by this exercise, each have turned one dollar into a little over $1 million. $225 million would have been lost, $225 million would have been won.

By then, this group will really lose their heads. They will probably write books on “How I turned a Dollar into a Million in Twenty Days Working Thirty Seconds a Morning.” Worse yet, they’ll probably start jetting around the country attending seminars on efficient coin-flipping and tackling skeptical professors with, “If it can’t be done, why are there 215 of us?”

By then some business school professor will probably be rude enough to bring up the fact that if 225 million orangutans had engaged in a similar exercise, the results would be much the same — 215 egotistical orangutans with 20 straight winning flips.

I would argue, however, that there are some important differences in the examples I am going to present. For one thing, if (a) you had taken 225 million orangutans distributed roughly as the U.S. population is; if (b) 215 winners were left after 20 days; and if (c) you found that 40 came from a particular zoo in Omaha, you would be pretty sure you were on to something. So you would probably go out and ask the zookeeper about what he’s feeding them, whether they had special exercises, what books they read, and who knows what else. That is, if you found any really extraordinary concentrations of success, you might want to see if you could identify concentrations of unusual characteristics that might be causal factors.

Scientific inquiry naturally follows such a pattern. If you were trying to analyze possible causes of a rare type of cancer — with, say, 1,500 cases a year in the United States — and you found that 400 of them occurred in some little mining town in Montana, you would get very interested in the water there, or the occupation of those afflicted, or other variables. You know it’s not random chance that 400 come from a small area. You would not necessarily know the causal factors, but you would know where to search.

I submit to you that there are ways of defining an origin other than geography. In addition to geographical origins, there can be what I call an intellectual origin. I think you will find that a disproportionate number of successful coin-flippers in the investment world came from a very small intellectual village that could be called Graham-and-Doddsville. A concentration of winners that simply cannot be explained by chance can be traced to this particular intellectual village."

[1] https://www8.gsb.columbia.edu/articles/columbia-business/sup...

great way to tell the masses and countless business school grads that its not even worth trying. Any astute investor will support articles like this since it reduces competition. Thinking is bad. Long live index funds.

Pretty funny that this apparently got flagged. Perhaps a couple entitled investors didn't like this particular message.

That's demonstrably false. How would you explain quants? All the financial firms that exist solely because of how good they are at buying and selling securities?

Says the professor who has never worked in the investment industry.

If your takeaway from this is most, if not all, investment is pure speculation, you are either very naive or willfully ignorant.

I'm nit saying talent per se is a signifixant factor, but this view suffers frim the sane nakady that a lot if wconomic theories do... an idealized situation/world where everyone plays by the rules. To some individuals, life is not a game, but a winner take all conflict and they will Kobayashi Maru the situation whille others are still playing a game of chance

In the short term, investing may indeed be more luck than talent, however this article strives to imply that market-beating results are essentially pure luck, which simply isn't the case over time. Over time, the best investors will always wind up with market-beating returns, and the worst investors will always wind up with market-trailing returns. Like any game with significant short-term variance, those with the greatest skill might not be readily apparent from a small sample size of results - I might beat Phil Ivey for a day or even a month at a poker table. But if we play long enough, I literally have no chance of being ahead of him. The same holds true for investors.

Articles like this seem like a cop-out for failed investors, and perhaps an argument for using index funds. If it's all luck, then your own failings aren't your fault. But that view doesn't apply to most areas of life, including and perhaps especially when it comes to investing decisions.

You're just asserting, i. e. "which simply isn't the case over time". The article build a model that appears reasonable, and from which follows that any talent allowing returns above 1% of the market would lead to a wealth distribution different from the one observed in reality.

Since you don't like my comment, if you read some of the other comments in this thread, you'll see that the model built in this article actually isn't reasonable at all (as I said). A small percentage of investors have achieved results that aren't possible through pure luck. So you are, in a word, wrong. Thanks for the downvote though.


> In 2006, Warren Buffett posed a challenge. He bet that the smartest hedge fund managers out there couldn't beat the world's simplest, most brainless investment. In this show, we tell you who's winning.

(index funds)

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