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At a recent all-hands meeting at Motley Fool headquarters, we played rock, paper, scissors.
That's right, in our first-floor conference room, 200-plus Fool employees -- investors, techies, editors, administrators, and even Fool co-founders David and Tom Gardner -- engaged in a head-to-head, "only the strongest will survive" rock, paper, scissors showdown. The competition was intense, and a cash prize awaited the winner.
The scene was rambunctious. But before long, the din quieted, the dust settled, and only two combatants remained: Thom Russell and Chris Evans. They'd each won an incredible five straight matches on their way to the final showdown. The room was positively electric as the two spit rounds on their way to one final, sudden-death throw. With bated breath, we all watched as Chris's flat-handed throw of paper bested Thom's close-fisted rock.
With cash prize in hand and an unblemished record, Chris was crowned a hero. How was it that he was so good at rock, paper, scissors? Did he have a method? Of course he did! And we all tripped over ourselves to find out what it was.
Anticipating the next companywide rock, paper, scissors showdown, Fool employees bootlegged copies of video footage from the meeting to study Chris' technique. You could hear the whispers around the office as championship hopefuls focused in on the footage. "Did you see what he did with his eyebrow there?" "He went rock, rock, scissors that round and then scissors, paper, rock the next!"
Before long, Chris was magnanimous enough to share his greatness, and he penned an eBook titled "Championship Techniques in Rock, Paper, Scissors: How You Too Can Cut the Paper, Smash the Scissors, and Win Big Cash in Tournament Competition." Motley Fool employees bought so many copies that the book rocketed to No. 1 in Amazon's "Games" category.
As word of Chris's amazing performance made its way outside the walls of Fooldom, the interview requests rolled in. Just days after the win, Chris sat opposite Katie Couric, sharing stories of his scissors-studying childhood and how a diet heavy in sugary cereals and a careful hand-moisturizing regimen aided his rise to the upper echelons of rock, paper, scissors.
There were doubters who questioned Chris's greatness. But they were dealt with easily enough. "Consider his record," his myriad fans would say, "if he wasn't great, how could he have gone completely undefeated for six straight rock, paper, scissors matches?" Further resistance was directed back to the video of Chris's epic championship win. Winners win! What more proof do you need?
This is, of course, a joke. Not all of it -- we did, in fact, have a rock, paper, scissors showdown at Fool HQ, and Chris Evans did win that showdown. But everything after that was a creation of my runaway imagination.
The story should sound familiar to fans of Warren Buffett though. Decades ago, Buffett wrote an essay titled "The Superinvestors of Graham-and-Doddsville." That essay begins with the story of a nationwide coin flipping contest in which a select few coin flippers got fabulously wealthy by "correctly" flipping coins over and over again.
The point -- whether we're considering Warren Buffett's coin-flipping contest or Chris Evans's impressive rock, paper, scissors victory at Fool HQ -- is that luck has a bad habit of masquerading as skill.
Legg Mason's Michael Mauboussin has distilled the skill vs. luck issue nicely, writing:
There's a simple and elegant test of whether there is skill in an activity: ask whether you can lose on purpose. If you can't lose on purpose, or if it's really hard, luck likely dominates that activity. If it's easy to lose on purpose, skill is more important.
You'd have to really contort yourself to come up with a reliable way to lose in either a coin-flipping contest or a rock, paper, scissors match. In other words, both activities are matters of luck (sorry, Chris). Even so, if observers were to focus on nothing but the final result, it may appear that the long string of "wins" points to outstanding skill.
It's sadly no different in the world of investing. Investors rabidly chase performance, rushing to whichever asset class, mutual fund manager, or TV guru has exhibited the latest string of wins. Far too seldom does the "skill vs. luck" determination come into their thinking, and the result is that most retail investors end up with returns that underperform basic indexes like the S&P 500.
Picking apart skill and luck can be done. Specifically, the more an investor can understand what process goes into achieving results, the more of an understanding he can come to about whether the results are reproducible or a happy fluke. Sure, it takes more work than simply looking at a results track record, but if your hope is to notch better results than the market average, you should expect to get your hands dirty.