Extremely successful? Extremely lucky!
Extremely successful? Extremely lucky!
People who are extremely successful as business executives or investors tend to think of themselves as more skilled and hard working than the average person. No doubt they are, but as you move towards the extremes of success, luck plays such an important role that the people who end up there are there almost entirely due to luck. No offense intended to any readers, just a matter of maths, as I will explain in this post.
We are all enthralled by the most successful people in the world. Jeff Bezos and Bill Gates are an inspiration to many aspiring business leaders and Elon Musk has become a rock star thanks to both his enormous business success and his personal antics. In the investment world, we look up to all time legends like Warren Buffet as well as star fund managers with a string of good returns like Cathie Wood in 2020. But Cathie woods spectacular fall from grace already indicates that not everyone who becomes a media darling for their extreme success does so because of their skill.
We all know that the performance of investors and business leaders alike is a combination of both skill and luck. But most people don’t realise that even if luck plays a minor role in general, it dominates at the extreme tails of the distribution.
To see how this works, I have simulated 10,000 investors (or business executives). I have simulated them as having skill for their chosen profession which is randomly distributed between 0% and 100%. At the same time, these fund managers are more or less lucky, with their luck also randomly distributed between 0% and 100%. Their total success is driven 95% by skill and just 5% by luck.
One would think that if luck plays such a minor role, becoming a top investor is mostly going to be a matter of skill, but one would be wrong. But here is the average luck score (i.e. how lucky the investors got) as you move from average to better and better performing investors.
Average luck of investors as their performance gets better
Source: Liberum
Of course, the average luck for all investors is 50%. Investors who end up in the top quartile or in the top 10% tend to have slightly better luck than average. But note that the investors who end up in the top 1% or top 0.1% have an awful lot of luck. Even though in our model, luck plays only a 5% role in determining success, to end up in the top 1% or top 0.1% you need to be very lucky indeed.
That also means if you follow the common approach of looking what the most successful investors or business leaders are doing, you are incredibly likely to follow lesser skilled individuals. The chart below inverts the process and looks at the likelihood that anyone ending up in the top 25%, etc. really has skill in the top 25%, etc. Among the top quartile investors, in our simple model, 97% of the investors with top quartile performance have top quartile skill. 94% of top 10% performers have top 10% skill. Bot only half of the top 1% performers truly have top 1% skill and out of the top 0.1% performers, only 1 in 10 truly has top 0.1% skill.
Share of investors with skill corresponding to their performance
Source: Liberum
And the numbers above are based on a model where skill is responsible for 95% of success. In real life (at least in the investment world) I suspect, luck plays a much larger role, somewhere close to 50%. The chart below shows the share of investors with skill corresponding to their performance if skill accounts for 55% of total performance and luck for 45%. Only 6 out of 10 top quartile managers truly have top quartile skills. And only 1 out of 7 top 1% investors truly have top 1% skills. Oh, and on average none of the top 0.1% investors have top 0.1% skills. They are all there because they have been very lucky indeed.
Share of investors with skill corresponding to their performance if luck accounts for 45% of performance
Source: Liberum
And now please realise that most, if not all of the people who read this, are in the top 1% of some sort. If you earn more than £50,000 a year, you are in the top 1% of global income. If you live in the UK and earn more than £58,300 a year (before taxes), you are in the top 10% in the UK and if you earn more than £180,000 a year, you are in the top 1% of the UK. That is you are in the top 1% of a country in the top 10% of all countries.
Great post!
Unfortunately, the fact that successful people believe their success comes mostly from their hard work has pretty bad consequences: they believe that if you are not successful it's your own fault and they fail to acknowledge that it's often largely determined by luck. Being poor becomes some sort of decision taken by people who just chose not to work hard enough. And who are the policy makers in our societies? Right, the successful people who were almost by definition very lucky (besides working hard, of course).
It's the same in finance or trading where the luck factor is probably even higher than in life in general.
Nice article, once again. This ↓ is amazing and needs constant reminding:
"If you earn more than £50,000 a year, you are in the top 1% of global income."
It is unbelievable how many of the people in the top percentiles underestimate the power of luck in their success and consistently overestimate their skills. I had also read somewhere that women are more realistic in their assessment of skills vs luck whereas most men think they are above average/top decile performers. This creates lot of problems once the results of the end-of-the-year performance assessments are issued.
If possible, could you share how you built the model and the simulation?