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Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.

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Improving Luck

Hi Guys,

“Chance favors the prepared mind” is a famous truncation of a Louis Pasteur quote.

A few days ago I mentioned that my wife just purchased Max Gunther’s 1977 reissued “Luck Factor” book. The subtitle of the book is “Why some people are luckier than others and how you can become one of them”. That’s worth exploring.

Chance does indeed favor the prepared mind, but all successful people acknowledge that luck is an influential factor in all their careers. Final positive and negative results often pivot on unforeseen factors that ultimately tilt the outcome in one direction or the other.

The military likes to talk about force multipliers. In everyday happenings, luck is a force multiplier. Folks who have studied both lucky and unlucky people have concluded that a person’s luck quotient can be augmented. Gunther offers several personal attributes that can be sharpened and actions that can be practiced that could enhance one’s luck quotient.

Gunther identifies four Luck Adjustment elements: the Spiderweb structure, the Hunching skill, action Boldness, and the Ratchet effect.

When applied to investing, the Spiderweb structure is an expanded number of financial contacts with divergent knowledge and interpretations. The MFO website and its membership serve to satisfy this need with its complex network of folks who volunteer information and meaningful guidance.

The Hunching skill deals with accepting the fact that we know more than we can immediately recall to form a cogent decision. At the decisive moment we feel that some decision is warranted, but we can not cobble together a precise logic chain to support that decision. Our subconscious stores data at various locations that can not be instantaneously accessed, but it’s there based on earlier learning and experience. We have a vague and clouded memory of it, and it forms the basis of our feelings, the source of our Hunch. Gunther recommends taking action on that Hunch.

History demonstrates that boldness is frequently rewarded. The bold enthusiastically seize opportunity when it is presented. The lucky seem to be bold; the unlucky seem to be timid. However, intemperate boldness can lead to faulty decisions and disastrous outcomes. Gunther emphasizes that boldness must be coupled to avoiding rashness. The investor must do a balancing act in terms of the risk-reward tradeoffs.

An investor recognizes that outcomes are uncertain. Total prescience is an impossible criteria when making an investment decision. Here’s where a probabilistic grounding that uses statistical databases can improve an investor’s luck quotient. It is prudent to prepare a safety net to accommodate unexpected events and unhealthy investment payoffs. Gunther names this the Ratchet Effect. He recommends that investors should be willing to admit an investment error, and be prepared to sell at some predetermined loss, like 10 % or 15 %. Any investor should have sufficient financial reserves to easily sustain these relatively minor disruptions. Never invest with grocery money.

This summary of Gunther’s Luck Factors takes us full circle to Pasteur’s chance favors the informed mind aphorism. What constitutes an “informed mind” for profitable investing?

I admire the financial works of Bill Bernstein. He had at least a partial answer to that question in his 2010 book “The Investor’s Manifesto”. Bernstein argues that most investors are doomed to fail (underperform the markets) because they, with a small percentage excepted, do not possess the requisite abilities. What are these requisite abilities?

Bernstein lists four: (1) a dedicated and continuous interest in the investment process, (2) a little math horsepower that includes some limited statistical and probability capabilities, (3) a historical perspective starting with the South Sea bubble, and (4) an emotional discipline to stay the course with a carefully crafted plan. He claims that Wall Street is littered with the bones of folks who knew what to do, but failed to do it. Execution is mandatory.

Much of what Bernstein says in his Manifesto couples tightly to the findings that Max Gunther summarized decades earlier. Fortune does not smile equally on everyone, but the odds for that winning smile can be enhanced with preparation, patience, and persistence.

Here are a few quotes that I culled from Bernstein’s book that reinforce some of Gunther’s work on the subject.

"The goal is not to maximize the chances of getting rich, but rather to minimize the
odds of getting poor." That’s the control risk axiom.

"Very high returns are almost always made by those brave enough to invest when
the sky is blackest." It’s tough being a contrarian, but the payday is huge because of the regression-to-the-mean market pull.

"Nothing is as likely to destroy your financial future as your own emotions." This is a caution against the (mis)behavior biases.

And finally, a brutally frank condemnation:

"The average stock broker services his clients in the same way that Baby Face
Nelson serviced banks." Bernstein has surely earned the privilege to slam an industry, but the criticism is far too broad for my comfort zone. I pass on this one.

You might want to read both books. They are breezy and easily read. I enjoyed both volumes, but not surprisingly, I was more impressed with the Bernstein effort because it contained an abundance of historical and statistical data. Enjoy.

Best Regards.


  • Dex
    edited March 2014
    If I could only say one thing to the young me (decades ago) it would be something similar to:
    "The goal is not to maximize the chances of getting rich, but rather to minimize the odds of getting poor." That’s the control risk axiom.

    Something like:

    "The secret to a successful life is recognizing and avoiding the stupid in yourself and the stupid around you."
  • edited March 2014
    Pretty good thought here MJG. Liked the "sky's the blackest" reference. But that's not a slam-dunk because there's no telling whether the sky may get even darker, nor how many months, years, decades that dark sky may last. (Case in point: Japan's experience). And, I don't discount the opposite approach, "momentum investing" (not that you did), as another good method for some - just not my inclination.

    I guess my biggest grumble per this and other recent posts (& guilty of it myself) is using words like "luck, fate or fortune" to describe investment outcomes. We all realize, I think, that we're actually talking about "probabilities". Probabilities can be estimated based on knowledge and past experience and can also be precisely calculated using mathematical equations. It's actually ironic I think that the often maligned John Hussman probably works more with and talks more about "probabilities" than most anyone else we discuss - yet all this mathematical/scientific calculating has led him in the wrong direction for more than a decade.

    Back to the "sky's darkest thought". I think that if one cautiously invests in a few dark sky ideas based on sound reasoning, knowledge, or intuition, the probabilities say he should be correct 51% or more of the time - given enough patience to wait for the turn-around. If that rate of success can be sustained, and if trading costs don't eat up too much of the gains, than this type of (diversified) dark sky investing might pay off. Regards
  • MJG
    edited March 2014
    Hi Hank,

    Thank you for your thoughtful and thought provoking reply. I certainly welcome it.

    Indeed it is a challenging and perhaps foolish chore to catch a falling knife. It is the ultimate loser’s game to step in-front of a runaway train anticipating that it will stop and reverse direction. I’m not brave enough (very limited boldness) to attempt either task and prefer to wait until the knife hits the floor and the train reverses itself.

    Although it is never absolutely predictable, if an investing dark sky will continue darkening or reverse itself, the markets do yield some imperfect and imprecise signals. Interpreting these signals is surely still more an art form than a science, but many professional investors assemble a host of these indicators when forming their judgments.

    A few of these indicators include the following items: a history review that identifies the frequency, the depth, and the time scale of market gyrations, assorted consumer confidence measures, the US leading economic indicator (LEI), the ISM purchasing managers index, some builder surveys, bond spreads, the US dollar index, market volume statistics, the trending of the advance-decline line, and a crystal ball. Every investor has the freedom to choose his own rules when, if ever, to catch a falling knife.

    A contrarians path is never easy; it demands great patience and persistence; it is a lonely road. It often devolves into many more investment losses in the hope of a few huge winners. Nassim Nicholas Taleb, of Black Swan fame, drove his employees nuts with his investment style. He knew that most of his investments would fail, but patiently waited for the Big Score. His employees felt like it was the equivalent to bleeding from a thousand small cuts. I suspect that Taleb’s Big Score came from his book royalties.

    I tell the Taleb story because of your statement that a risk-seeking investor wants a 51 % success score. That’s not necessarily so.

    As we all know, a payoff is not simply the likelihood of winning; the payoff odds are part of the success equation. The operative equation in terms of an investment decision is an expectation of positive net returns. The sum of the positive expected payoffs (probability of success times payout) must exceed the sum of the negative expected payoffs (probability of failure times losses incurred) to justify an investment.

    As Taleb recognized, advocated, and practiced, a few huge winnings could overwhelm many limited losses. I’ll emphasize that that is Taleb’s philosophy and style; it is not mine.

    Once again, thank you for contributing your opinion on this subject. All such submittals add to the wisdom of the MFO crowd.

    Best Wishes.
  • Terrific post, MJG. One day I will read Mauboussin's books...

  • All of this is well and good to know but as an observer I don't have to know all of this - but I would hope my educated fund managers have a vast knowledge of this and can analyze and react in a profitable way. This is what I know. - Most of us are paying a little over 1% management fee. On a $ 420,000 fund that's about $ 350 a month management fee. You never gat a bill from the fund company. I an more interested in the bottom line.

    Reference source: Da FOOL

  • Hi Gary,

    Simplification is usually beneficial, but over-simplification can be financially hazardous. I believe an investor needs to know as much as possible when assessing financial matters. Constant learning is essential to improve investing outcomes.

    Hiring a fund manager or a team of managers does not relieve you of your portfolio management duties. It is just one step in the process. Yes, buying a mutual fund or ETF does transfer some of the investment tasks to the fund manager, but not all of them. You’re still the most important cog in the investment decision wheel.

    So continue educating yourself on financial matters or risk ruin from the many professionals who will gladly exploit your blind spots. These guys are experts at filling their pockets while providing services that either fill or empty your pockets. As you correctly emphasized, fees are a persistent annual portfolio drain regardless of market outcomes.

    There are simple strategies to substantially decrease this reward drain. Warren Buffett observed that “Beware of little expenses; a small leak will sink a great ship”.

    Yale institutional investment genius David Swensen authored his “Unconventional Success” book in 2005. He likes to say that both amateur and professional investors only have 3 tools to work their magic: asset allocation, market timing, and security selection.

    By hiring a fund manager, you transfer 2 of these 3 tools to his responsibility: the specific security choices and some of the market timing aspects. However, you fully retain the asset allocation responsibilities. David Swensen concludes that the asset allocation function contributes at least 80 % to the overall returns profile whereas the other two functions each only add 10 % to the returns picture.

    Here is a Link to a recent Swensen lecture that he delivered as a guest on Robert Shiller’s economics and finance series:

    In his book, Swensen said: “Poor asset allocation, ill-considered active management, and perverse market timing lead the list of errors made by individual investors.” Remember, you are still responsible for at least the asset allocation decisions.

    Costs always matter and individual investors are always exposed to potentially escalading investment charges, some obvious and some hidden.

    The private investor and his portfolio suffer from a triple whammy in this regard that is a heavy burden to overcome. The triple whammy for the individual investor is: (1) the fund and advisor fees, (2) the average underperformance of active fund managers to just match passive Index outcomes, and (3) the poor exit/entry timing of the investor himself.

    All three factors are frictional drags that substantially reduce the private investors annual returns to approximately one-third of overall market returns. Countless academic and industry studies document this dismal shortfall.

    The simple strategy to substantially attenuate this wealth robbing burden is to eliminate the second tier of advisor fees, to invest in low cost mutual fund and ETF products like Index funds, to avoid frequent trading that is tied to short term market timing, and to be alert to behavioral biases like overconfidence and herding that encourage faulty market decisions.

    The MFO membership is dominated by folks who own mutual funds and ETFs. As a group, we recognize and reserve the asset allocation and the long-term entry/exit decisions for ourselves. To execute this task with some success, each of us continually upgrades our knowledge base by learning and with experience. I suggest that you will enhance your portfolio’s growth prospects by also adopting this learning pattern.

    Thank you for your participation in this exchange and thanks for the Link.

    Best Wishes.
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