MW Warren Buffett's mentor said his wealth came down to luck. Is your life savings riding on a coin flip?
By Mark Hulbert
The illusion of investing knowledge is powerful: Why you're probably paying a financial adviser for pure chance
Is investing success a matter of luck or skill?
Lucrative investment performance is far more a function of luck than any of us like to admit.
Imagine at the end of February being told that the U.S. would be involved in a war in the Middle East and that oil prices and inflation would both surge. I seriously doubt that any of us would have predicted that the U.S. stock market, given those events, would have rallied to record highs.
All of which shows that market forecasts depend on an indefinitely large number of factors and assumptions. If any one of those factors and assumptions failed, the forecast would not hold.
The odds of failure are far higher than of success. This point was made by Howard Marks, co-founder and co-chairman of Oaktree Capital Management, in an essay I highly recommend entitled "The Illusion of Knowledge." Marks writes: "I imagine that for most money managers, the [decision-making] process goes like this: 'I predict the economy will do A. If A happens, interest rates should do B. With interest rates of B, the stock market should do C. Under that environment, the best-performing sector should be D, and stock E should rise the most.' The portfolio expected to do best under that scenario is then assembled."
He adds: "But how likely is E anyway? Remember that E is conditioned on A, B, C and D. Being right two-thirds of the time would be a great accomplishment in the world of forecasting. But if each of the five predictions has a 67% chance of being right, then there is a 13% probability that all five will be correct and that the stock will perform as expected."
Some years ago, UCLA professor Brad Cornell devised a test that measures the relative roles of luck and skill. After putting a sample of hundreds of U.S.-stock mutual funds to this test, Cornell concluded that 91.8% of the differences in those funds' annual returns was "attributable to random chance." I reached a similar estimate of luck's share of performance - 93.9% - when I subjected the investment newsletter portfolios monitored by my performance auditing firm to Cornell's test.
How to know if your adviser has genuine skill
One implication of these results is that your investment adviser or portfolio strategy needs to outperform the market for many years - decades, in fact - before you can gauge ability with statistical confidence.
How many years depends on two factors: The average margin by which your adviser beats the market ("alpha") and the volatility of portfolio return. For a manager with an annualized alpha of 5% (higher than almost all managers on Wall Street) and a standard deviation of annual returns of 20% (slightly more than the market but lower than most funds or strategies), it would take 64 years of such performance to know at the 95% confidence level that the adviser has genuine ability.
If a manager's or strategy's alpha is less than 5%, or the standard deviation of return is higher than 20%, then the required length of time is even longer. Consider the Fidelity Magellan Fund FMAGX, which has one of the best long-term returns of any U.S. equity fund. Yet given its alpha and volatility, the fund would need to perform just as well for more than 100 years to demonstrate, at the 95% confidence level, that its manager had genuine market-beating ability - even assuming that the fund had the same manager throughout.
In almost all cases, therefore, we're forced to choose an adviser or strategy without having statistical confidence in his or its genuine ability. That doesn't mean past performance is irrelevant. But it does mean that choosing an adviser or strategy involves a big stroke of luck.
For most investors the investment implication is to buy and hold a broad-market index fund, which over time reliably beats 90% of managers vying to outperform a benchmark index.
Is it better to be lucky or smart?
This discussion of luck's role in investing wouldn't be complete without acknowledging a much-underappreciated comment Benjamin Graham made near the end of his life. Graham was the father of fundamental investing and Warren Buffett's teacher and close friend.
In a postscript to a later edition of his book "The Intelligent Investor," Graham reflected on the debt his lifetime track record owed to just one company - Geico. He reported that the profits his firm earned by investing in Geico stock "far exceeded the sum of all the others realized through 20 years of wide-ranging operations... involving much investigation, endless pondering, and countless individual decisions."
Furthermore, when investing in Geico, now a unit of Berkshire Hathaway $(BRK.A)$ $(BRK.B)$, Graham's firm violated several of his own investment principles. Put simply, but for the profits Graham's firm earned from this one stock, Graham probably would not have earned the reputation he did.
In drawing the moral to this experience, Graham wrote: "One lucky break, or one supremely shrewd decision - can we tell them apart? - may count for more than a lifetime of journeyman efforts." That's an incredible admission for someone who dedicated his career to reducing the role luck plays in investing.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
-Mark Hulbert
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June 17, 2026 18:48 ET (22:48 GMT)
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