We often read about how certain individual make a huge return on their portfolio. Or it could be your friend who has recently shared how their investment has increased by 1000%. Which brings us to the question of whether that is just pure luck or is that skill.
When it comes to investment, no doubt it is important to continually learn and sharpen your investment analysis skill. There are however two extremes:
- First being having pure luck with no skills whatsoever.
- The second being having the right skill but zero luck.
Both these scenarios are at the extreme end. Often time, it will be in between these two extremes.
An individual who has no skill can speculate on a single stock and make a huge return purely based on luck. Likewise, another individual who has vast knowledge in investing and have done his research can buy a stock and make a huge loss just because luck is not on his side.
So while having the right skill is vital when it comes to investing, luck plays a role as well.
Differences between speculating and investing
To understand the concept of luck and skill better, we will look into the two terms we commonly heard of; speculating and investing.
Investing involves a vast understanding of the business and a commitment as though you are invested into the business itself. It involves a diligent process where often time investor buy based on what they think the stock is worth.
When it comes to investing, an individual will need the right skill to screen and identify the potential stock opportunity. And sometimes with little bit of luck, your investment will grow tremendously.
Speculating on the other hand involve buying on a stock without any basis with the hope that the stock will be a one-hit-wonder. Some of the examples is an investment based on stocks tip where there is no basis on why you invest in the stock. You invest with the hope that the stock will be a hit. In those circumstances, it is then purely based on luck.
It sounded like the same thing but if you were to look closely;
- Investing rely mainly on skills and hopefully, luck will be on your side
- Speculating, on the other hand, relies mainly on luck
Role of luck in investing
Some of you might not agree that luck plays any role in investing. Here are some examples which might prove otherwise.
As an investor, you can spend tons of hours researching and finding the best stock. Say you found it and enter into a good trade. Sure you will make some money cause no doubt the stock has strong fundamentals. But to make a gain of 1000% of your investment, you require a little luck and patience. Nobody would be able to predict that Google would grow to where it is today. Similarly, you cannot foresee what would happen in the future. A stock you have handpicked might have dropped due to an unforeseen event beyond anybody’s control. Now, this is then not having luck on your side.
Hence, a little luck goes a long way. But without the right skill and hard work, you cannot get lucky.
Another great example is on the timing of entry. With the right skill, you would have identified a great stock opportunity. On a similar stock, both investor A & B had decided that buying at a price of USD 5 is a bargain.
Investor A bought 10,000 stock one day earlier at a price of USD 5. Investor B who was supposed to buy at the same time missed out due to some technical issues with his brokerage account and so decided to buy the next day. What happens is that the next day, the share price drop to USD 4 due to a short term market reaction. Investor B then seize the opportunity by buying 10,000 stocks at a price of USD 4.
Fast forward today, the stock is traded at USD 10. Just from the timing of the entry, Investor B has an unrealised gain of USD 10k more than investor A. There is nothing wrong with investor A and B. The only differences being that investor B has more luck than investor A and hence, make a higher return.
The point is that nobody can time the market. Hence, a little luck helps in investing.
Now that we have illustrated the above, how can you then use luck to your advantage. While luck plays a role in investing, equipping yourself with the right skills and knowledge is still key.
How to use luck to your advantage?
The best way to position yourself is to apply the right skills when it comes to investing and let luck plays it out. Not the other way round. While you cannot predict what would happen in the future, you can however control which company you choose to invest in. The idea is to do your diligence to reduce the risk as much as possible.
Let us know what you think.
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