Are you a skilful investor? Or just plain lucky?
If behavioural finance theory is anything to go by, most people with out-performing portfolios will claim skill is behind their performance. It's all because of basic human nature and over-confidence — everybody claiming to be an above average driver and so on — and it's something that never goes down too well in financial markets!
But how can you actually tell if your stock market success was the result of genuine skill or a large dose of luck? Here are four points to consider:
1) Strategy
How do you select your shares? Those blessed with skill always seem to be able to articulate a clear philosophy, do their own research and provide a full explanation of every portfolio holding.
In contrast, those with luck on their side will probably refer to tips from a mate, newspapers, magazines and own a ragbag collection of different companies without any common theme. (Remember: books about investing legends never refer to chance punts on blue-sky penny shares.)
2) Timescale
So how long does it take to separate the expert investors from the lucky punters? Generally speaking, luck in the markets can play a big part for anything up to five years. But beyond that — especially if it includes a change in economic conditions — the cream will start to rise to the top.
Obviously the longer the decent performance, the more likely it's been based on ability (surely nobody can describe Warren Buffett's 35 years of superlative returns as a fluke!) On the other hand, Lady Luck will — sooner or later — run out on the speculator.
3) Consistency
Calculate your success rate. If you're up on the market over several years and at least six out of every ten shares you've picked have done well, then it's likely a degree of talent has supported your portfolio.
Conversely, if any out-performance has stemmed from one big winner, repeating the trick could be difficult and may indicate luck was a significant factor.
It's the same for your annual performances. If you've outrun the market in most years, you probably have some talent. However, if you've had one mega year and no end of bad years — but still have beaten the market overall — appreciate your good fortune.
4) Failure
How do you deal with the losers? Beware blaming company directors, the share market itself, the government — basically anybody but yourself — for your portfolio mishaps.
You see, it's illogical to claim winning shares were picked with your own skill yet losing shares were down to unforeseeable events and 'bad luck'. The truly skilful stock picker always accepts he will make mistakes and blames the only person who can ever be responsible for the loss — himself.
How do you shape up?
We think we're skilful. But, like everyone else, we're also above-average drivers. To find out for yourself, sign up to our free email, Take Stock. We'll be exploring investing strategies, pontificating on the state of the global economy, plus much more.
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