ISMS 24: Larry Swedroe – Confusing Skill and Luck Can Stop You From Investing Wisely

In this episode of Investment Strategy Made Simple (ISMS), Andrew and Larry discuss two chapters of Larry’s book Investment Mistakes Even Smart Investors Make and How to Avoid Them. In this fourth episode, they talk about mistake number 7: Do you confuse skill and luck? And mistake number 8: Do you avoid passive investing because you sense a loss of control?LEARNING: When gauging a fund manager’s performance, consider risk-adjusted performance. If you’re a passive investor and use a systematic strategy, you’re 100% in control. “You have to accept that you can only control what you can control; you can’t control the unpredictable things that happen.”Larry Swedroe In today’s episode, Andrew continues his discussion with Larry Swedroe, head of financial and economic research at Buckingham Wealth Partners. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.Larry deeply understands the world of academic research and investing, especially risk. Today Andrew and Larry discuss a chapter of Larry’s book Investment Mistakes Even Smart Investors Make and How to Avoid Them. In this fifth series, they talk about mistake number seven: Do you confuse skill and luck? And mistake number eight: Do you avoid passive investing because you sense a loss of control?Missed out on previous mistakes? Check them out:ISMS 8: Larry Swedroe – Are You Overconfident in Your Skills?ISMS 17: Larry Swedroe – Do You Project Recent Trends Indefinitely Into the Future?ISMS 20: Larry Swedroe – Do You Extrapolate From Small Samples and Trust Your Intuition?ISMS 23: Larry Swedroe – Do You Allow Yourself to Be Influenced by Your Ego and Herd Mentality?Mistake number 7: Do you confuse skill and luck?According to Larry, investors don’t know statistics well enough to differentiate skill from luck. To understand if an outperformer is outperforming because of skill and not luck, look at risk-adjusted performance. So, for example, over the very long term, value stocks have outperformed growth stocks, and small stocks have outperformed large stocks. So somebody who outperforms simply because they owned lots of small and value stocks more than the market isn’t outperforming on a properly adjusted basis. Other factors than size and value, such as momentum, profitability, or quality, can also drive the return. Larry recommends Portfolio Visualizer, a tool that shows how much exposure an active fund has to those factors. It also reveals the alpha or the remaining performance that cannot be explained.The second thing you need to consider is whether the fund’s assets are growing. If they’ve