As Samuel Goldwyn once said, "The harder I work…the luckier I get!" 1 But when it comes to investing, luck may play a huge role in outcomes—no matter how hard you work.2 Below, we discuss some ways that luck may impact your investing, as well as some steps you may wish to take to try to make your own good luck this St. Patrick's Day.
The Impact of Luck on Investment Returns
One reason so many financial professionals advise against market timing for long-term investors involves the distribution of days with major gains and days with major losses. Historically, and particularly seen during the earliest days of the COVID-19 pandemic, some of the market's best days were followed by some of its worst, and vice versa.3
Trying to sell at the top and buy at the bottom may require a great deal of luck. You may need to trust that a day with a 2 or 3 percent loss may not be immediately followed by a day with a 2 or 3 percent gain. However, over the course of a long investing horizon, these single-digit gains and dips aren't likely to have a major impact unless you make a habit of buying and selling during volatile periods.
Focus On Process, Not Prior Results
How can you take advantage of good luck and avoid the impact of bad luck when choosing your investments? The answer may be complicated and may depend on your personal circumstances. However, by focusing on the investment process—rather than chasing returns by buying into funds that have recently had a good run—you may be more likely to pick a future winner.
Having a solid process may increase your probability of investment success over time. With your financial professional, consider focusing on these three steps:
- Discuss your financial professional's analytical process. How does your financial professional choose funds? How does he or she know whether it's time to dump underperforming funds or stick around for a future rally? By having some insight into the process your financial professional uses to choose their investments, you may determine whether this approach fits your risk tolerance and desired asset allocation.
- Ask whether this process is designed to manage and mitigate some of the behavioral biases that may send investments off-course. Some of these biases include overconfidence, sunk cost fallacy, and anchoring of sources. Ensure that your financial professional is reading and absorbing information from a variety of solid sources.
- Once an investment or set of investments has been chosen, evaluate it with an eye toward its end user. Is this investment intended to provide high commissions that enrich the investment company more than the shareholders? Or does it provide an excess return that more than accounts for its fees? Compare the investments to their benchmarks to see how they've performed over the years.
Sifting through which successes are attributable to luck and which to skill may be tricky. But by firming up your investment selection process, you may improve your own luck and increase your likelihood of success.