Archive for December, 2012

Michael Mauboussin: Investment Success Which Matters Most? Luck or Skill

December 7, 2012

Luck versus skill in investing! How much does each matter to investment success? Our guest this week, Financial Thought Leader Michael Mauboussin has written a new book on the topic. Titled The Success Equation: Untangling Skill and Luck In Business, Sports and Investing, its conclusions might surprise you. Continue Reading »

CHECK OUT THE IMPACT COSTS ARE HAVING ON YOUR PORTFOLIO

December 7, 2012

Use Vanguard’s “The Truth About Costs” tool on their website –  you can see the returns lost and the returns kept over different periods of time depending upon the expense ratio paid and the average annual return you are expecting.

 

Watch this Episode

Michael Mauboussin on landing his first job

December 7, 2012

A Financial Thought Leader who has written a fascinating new book titled, The Success Equation: Untangling Skill and Luck in Business, Sports and Investing. Author Michael Mauboussin is the Chief Investment Strategist at Legg Mason Capital Management as well as an award-winning Adjunct Professor at Columbia Business School. In his book, he analyzes how and when luck and skill intersect to produce successful results. He concludes, surprisingly, that luck plays a big role in success, as he explains here in extra with the story behind landing his first job!

 

Watch this episode of WEALTHTRACK.

Michael Mauboussin Transcript 12/07/12 #924

December 7, 2012

WEALTHTRACK Transcript

#924- 12/7/12

 

CONSUELO MACK: This week on WEALTHTRACK, how much of a role does skill play and how much does luck contribute to investment success? Financial Thought Leader Michael Mauboussin, Chief Investment Strategist at Legg Mason and author of The Success Equation, gives us some tips on how to beat the odds. Next on Consuelo Mack WEALTHTRACK.

 

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. How much of a role does skill play and how much does luck really contribute to investment success? Those are the fascinating questions posed by this week’s guest in his new book, The Success Equation: Untangling Skill and Luck in Business, Sports and Investing.

 

He is Financial Thought Leader Michael Mauboussin, who is the Chief Investment Strategist at Legg Mason Capital Management, as well as an award winning adjunct professor at Columbia Business School, where he has taught finance for the past twenty years. He is also the author of several books, including More Than You Know: Finding Financial Wisdom in Unconventional Places, which was named one of the best business books by Businessweek magazine.

 

In our never ending quest to identify the best investments, strategies and professionals to help you build long-term financial security, luck almost never comes up. We along with everyone else are always focusing on measurable data such as performance, price, correlations, and economic and market trends. We also look at processs, such as a firm or fund’s investment approach, a manager’s analytical skills and investment discipline, and we pay attention to less tangible attributes, their professional standing, behavior through different market cycles, and reputation for honesty and integrity. But how do you figure luck into the equation, which according to Mauboussin, has a lot to do with investment success? Here’s what he has to say.

 

MICHAEL MAUBOUSSIN: So it turns out luck is very important, especially for short-term results, but it’s maybe not for the reason you think. I like to actually call this the paradox of skill. The reason luck’s so important is because precisely investors are so skillful.

 

Let me try to explain this a little bit different way.  There’s a great essay that was written about 20 years ago by Stephen Jay Gould. He was a famous biologist at Harvard, and it was about Ted Williams who hit .406 in baseball in 1941, and the question Gould asked was, why has no one done that since? So he looks at some conventional things like, you know, they play at night or they travel. None of those things made any sense. It turns out the reason no one has hit .406 is because everyone’s gotten better, and as everyone’s gotten better, skills become more uniform. There’s less variance or difference between the best and the worst.  So even if luck plays the same role, lesser variance in skill means batting averages come down. And to make that a little bit more concrete, if Ted Williams were to play now, the same statistical equivalent of his performance in 1941 would be about a .380 batting average, so quite a bit less. So I call it the paradox of skill, because it says more skill actually leads to more luck in results.

 

CONSUELO MACK: So Michael, why do we constantly underestimate the role that luck has in our investment success?

MICHAEL MAUBOUSSIN: This is such an interesting question, because if you look into the future and say to people, “Hey, future outcomes are a combination of skill and luck,” everybody gets that. Right? Everybody sort of understands that’s the case, but when looking at past results, we have a much more difficult time, and I think the answer to this comes from actually neuroscience. Brain scientists have determined that there’s part of your left hemisphere in your brain which they call the interpreter, and the interpreter’s job is when it sees an effect, it makes up a cause and, by the way, the interpreter doesn’t know about skill and luck, so if it sees an effect that’s good, let’s say good results, it says, “Hey, that must be because of skill,” and then your mind puts the whole issue to rest. It just sets it aside. So we have a natural sort of module in our brain that associates good results with skill. We know it’s not always the case for the future, but once it’s done, our minds want to think about it that way.

 

CONSUELO MACK: Therefore, do we repeat, when we’ve had a success that we attribute to our skill, do we constantly repeat those same moves in order to get the same result?

MICHAEL MAUBOUSSIN: I think it kind of gets to one of the biggest mistakes you see in the world of investing. Right? Which you say, now you want to put some money to work in the market, and say you want to go buy a mutual fund. How do you usually do that? Well, usually you go to a reputable investment firm, and then you scan the funds and you see what has done well, and you say, “Well, that must be the best thing,” and often you invest in what’s done well, and this is a pattern we’ve seen not only with individuals but also institutions: buying what’s hot and inversely often getting rid of what’s cold, and that ultimately is very poor for investor results. It’s about a percentage point per year reduction in long-term results for individual investors because of this effect of buying high and selling low.

 

CONSUELO MACK: So that’s interesting. So help us understand what skills really count. If everyone on Wall Street is getting smarter and has the same set of skills or at least I don’t know if they’re getting any smarter, but their research is getting better; their analytical tools are getting better. That’s what you mean about the skill set has raised on Wall Street, right? So what are the kind of skills that we look at that would differentiate an investor from the pack, from the rest of the Street?

MICHAEL MAUBOUSSIN: So first let me say that in some realms like music, for example, or athletics, skill is pretty clear. Everybody’s heard about this 10,000 hours and deliberate practice, and where skill dominates, that is the right way to think about it, but when you get to worlds that are probabilistic like money management where what you do, you don’t really know what the outcome is going to be, then it becomes a process and, to me, successful investing has three components to the process.

 

The first would be analytical, and analytical to me means finding stocks for less than what they’re worth, or in the jargon means getting an investment edge, and second and related to that is putting them into the portfolio at the proper weight. So it’s not just finding good investment ideas, but it’s how you build a portfolio with those investment ideas. And by the way, a lot of people in the financial community focus on buying attractive stocks, but the structure is actually really important as well, so that’s the first component.

 

CONSUELO MACK: Okay, so that’s a real discipline and a real process, right? And aren’t there a lot of people doing that, though, on Wall Street?

MICHAEL MAUBOUSSIN: There are a lot of people doing it, although the portfolio positioning, I think there’s room for improvement there. That leads to the second thing, which is more difficult to do, and that is behavioral and, you know, in the last 15 or 20 years there’s been burgeoning work in behavioral finance, and there tend to be two sort of broad threads to that. The first is what’s called heuristics and biases which is fancy words for saying heuristics are rules are thumb, and what psychologists have discovered is most of us walk through life with all sorts of rules of thumb which save us a lot of time, so they’re good, but they come with associated biases, and those biases often lead to suboptimal decisions. So as an investor, it’s really crucial to be aware of what those rules of thumbs are and the biases that come with them, and then work on managing and mitigating those.

 

CONSUELO MACK: So can you give me an example of a rule of thumb that an investor might be working with and understanding what the bias is?

MICHAEL MAUBOUSSIN: Sure. So a couple of examples: one would be over confidence. We tend to be very over confident in our own capabilities. You can show this with simple little tests, and the way that tends to show up in investing is people, when they’re projecting out into the future, they’re much more confident about the range of outcomes, so they make a very narrow range of outcomes rather than a much broader range of outcomes. So there would be one example, over confidence, and its manifestation.

CONSUELO MACK: Okay, so that was one part of this process.

MICHAEL MAUBOUSSIN: Behavioral.

CONSUELO MACK: Yeah, the behavioral processes and be aware of the rules of thumb and your bias, and the biases that they have, but then once you’re aware of them, what do you do?  You just try to overcome them or balance them?

MICHAEL MAUBOUSSIN: Exactly. So try to weave into your process tools and techniques to manage and mitigate them. I don’t think you can ever fully eradicate them, but just be aware of them and learning about them. So for example, in the over confidence, you can start to use tools to better calibrate the future, for example, using past data or making sure you’re pushing out your ranges appropriately. So there are, in every case, some tools to help you manage that.

 

CONSUELO MACK: And then there was a third part to this, I think, that you were talking about. Again, the process of…

MICHAEL MAUBOUSSIN: The third part is organizational, and many of your guests over the years have talked about this, you know, Jack Bogle and David Swensen and Charley Ellis would be some examples, and here are the cases thinking about managing for the profession instead of the business. And what does that mean? The profession means really having the interest of the shareholders of the fund first and foremost. The business would be generating fees and revenues for the company. Now, to be clear, a good profession requires a healthy business, so these things have to go together, but when the pendulum swings too far from the profession to the business side, that can be problematic. So when you step back and say analytical, behavioral and organizational, what I would say is many investment firms are pretty good in one or two of those areas. Very few are really good on all three, and that is what you’re looking for in a really good investment process as an investor.

 

CONSUELO MACK: As an outside investor, and a lot of our viewers on WEALTHTRACK invest in mutual funds, so how do they judge the analytics and how do they judge the behavioral, and how do they then judge whether they have my interests ahead of their business, you know, their bottom line interests?

MICHAEL MAUBOUSSIN: So the first thing I would say is something you’ve also talked a lot about on the show over the years is, for many people, indexing makes sense. Right? Low cost exposure to markets, so you don’t have to fuss with it at all. So that is one way. Now, if you do want to go with active management, I do think it makes sense for a lot of people, there are some things you can do. One is to make sure, for example, that the fees are competitive and the organization itself is reputable, but if you really want to drill down, I will mention one tool I think gives a very interesting insight into the process of the organization, and that is a concept called active share. So let me explain this, it’s pretty straightforward. Active share says it’s a range from 0 to 100 percent. It was developed by a couple of academics.  Zero active share percent is an index fund, so say the S&P500. You’re identical. One hundred percent is completely different than the index. Right? So you go from 0 to 100 percent.

There’s a second little dimension of that which kind of adds to the cocktail called tracking error, and tracking error is a measure of how different you are than the benchmark. Now, the simplest way to think about this is that active share is an indicator of stock picking, so how good you are kind of getting down and dirty and picking the best stocks, and tracking error is an indicator of what they call factor bets: I’m bullish on the economy, so I’m going to buy economically sensitive stocks, or I’m bearish, and so I’m going to be very defensive. It turns out when you look at 25 years of data, it is those funds that have high active share but moderate tracking error. So they’re really focused on stock picking, not so much big bets on the economy. It is those funds that tend to do best over time. So I think if… and by the way, there are a lot of services now that report active share including Morningstar, so for investors that are really motivated, take a look at the complex. Make sure the fees are competitive, and then take a look at this active share as one potential way to gain some insight into a process.

 

CONSUELO MACK: What’s interesting is we’ve just come through a period where we’ve heard over and over again that macro matters, and so that it’s one thing to have been a very bottom-up focused mutual fund, but if you missed the fact that the Fed was going to, you know, ease for four years or five years or whatever it’s going to end up being, that you missed major market moves. You had this risk on/risk off. So in fact, kind of, people are saying, you know, throw all of that out the window, or that… I’ve had a lot of value investors come on who have very good long-term track records, saying, “You know what? I didn’t used to pay attention to the macro. Now I really have to pay attention. It really matters.”

MICHAEL MAUBOUSSIN: The first thing I would say about this, is this is an area of prediction that’s been very well studied, and my favorite scientist on this is a psychologist named Phil Tetlock at University of Pennsylvania who did an exhaustive study of predictions in social, political, and economic outcomes, and what he found, I think, beyond a shadow of a doubt is that experts are very poor at predicting the future. So while I know people are worries about getting whipsawed by macro events, the evidence that anybody can anticipate exactly what’s going to happen next is very, very weak. So that’s the first thing, is just to be very reserved about your belief in your ability to anticipate what’s going to happen next.

 

The second thing, I think, Consuelo, really focuses a lot of on time horizon. So if you say to me, “What’s going to happen in the next three to six months?” it’s just very, very difficult to do, and that’s where this risk on/risk off, that’s the kind of time horizon people are talking about.  If you say, “I want to really think about longer cycles, three to five years or perhaps even out 10 years plus,” those sort of wiggles become less important. So I would just be mindful. Obviously, you want to be mindful of macro. I don’t want to say you be dismissive of it. I would say macro aware, but in some ways macro agnostic.

 

CONSUELO MACK: You’ve just written a book called The Success Equation: Untangling Skill and Luck in Business, Sports and Investing. If, in fact, that luck plays a greater role than skill or a very large role in investing than skill does, so is there any way to manage luck?

MICHAEL MAUBOUSSIN: So the first thing is there’s one way to frame this whole issue is to think about a continuum from all luck, no skill to all skill, no luck, and to your point, if you’re over on the luck side, it’s very important to recognize it. Now in investing, I would say that there is differential skill. I want to be clear. I don’t think it’s all luck.

CONSUELO MACK: No, no. Sorry.

MICHAEL MAUBOUSSIN: I think there’s a lot of luck, but that’s a very important thing. So I would just say, stepping back as an investor, what you probably want to look at are a couple things. One is, what does the valuation of the asset class look like? What does the valuation of equities versus… and you can do simple things like price earnings ratios or dividend yields or more sophisticated things like cash flow multiples and so forth and look at those versus fixed income or risk-free equivalents. When you start to see things that are cheap, and you take a long-term point of view, that’s probably the best foundation you would require to make good decisions.

 

CONSUELO MACK: So one of the chapters in The Success Equation has to do with statistics, and it’s what makes for a useful statistic, and so that sounds really dry, but in fact it’s very important. So talk to me about predictive qualities and persistence and how we can apply the useful statistics chapter to our investing process.

MICHAEL MAUBOUSSIN: I mean, the first thing to say is that we swim in statistics, right, every day. You turn on the television. You watch a baseball game. They’re all over the place, and it stands to reason that they’re not all of equal value or usefulness for us, and so there’s a simple test, a two-step test to determine whether a statistic is useful. The first is that it’s persistent, and persistent means that what happens in the current period is highly correlated with what happened in the last period. So, for example, you took the SATs a month ago. Now you take the SATs today, and you get a very similar score.

 

CONSUELO MACK: You hope that your score… right, right.

MICHAEL MAUBOUSSIN: And if you get a very different score, then that would be something that’s not persistent. So that’s the first thing, is persistence. The second is something called predictive which is, does it serve the end goal I’m trying to achieve? So it would be correlated with your end goal.

 

One of the great ways to explain this is through Moneyball, this very famous book that Michael Lewis wrote that came out a dozen years ago, and there’s sort of a contrasting look between batting average for baseball players called on-base percentage, and it turns out that batting average has a lower correlation from period to period, so it’s less persistent than on-base percentage, and the ultimate objective is to score runs. On-base percentage has a higher correlation with scoring runs. So you win on both of those, persistence and predictive value, and so that was what the Moneyball guy saw, and they also saw that it was improperly priced in the marketplace, and they could take advantage of that and build a successful team on the cheap.

 

CONSUELO MACK: Okay, so take that analogy and apply it now to the markets and to succeeding in the markets.

MICHAEL MAUBOUSSIN: Right, so the most common method we all do to find a fund is to look at what’s done well before, right?

CONSUELO MACK: Right, past performance.

MICHAEL MAUBOUSSIN: Past performance, and by the way, I should say that is an approach if you parse it. There’s some academics that know how to do this very carefully, and they massage it, and they add these adjustments to it. They can start to get a better look at it, but for most of us, no chance. What’s done well? So the persistence of excess returns is basically zero, so as they say, past results are no indication of future results.

 

CONSUELO MACK: And that is true.

MICHAEL MAUBOUSSIN: And that is true.

 

CONSUELO MACK: So one of the things as well that can determine one’s own personal investment outcome is your own behavior, and so that’s something that we’ve talked about, but I know that Morningstar’s also tracked, as has Jack Bogle in his Vanguard research, has tracked how individuals who actually invest in mutual funds, how poorly they do compared to the mutual funds they actually invest in. So do we need to understand our biases as well as… I mean, you can buy the best fund in the world, and if you’re trying to time it, you can lose, and you consistently won’t do as well as the fund itself. So how do we figure that into this process?

MICHAEL MAUBOUSSIN: Consuelo, this is such a big issue. I call these the most depressing statistics in investing, and I think the last 20 years I’m going to get these numbers wrong, but it’s in the ball park. The S&P has returned about nine percent in the last 20 years, the average mutual fund about seven and a half percent, and the difference between that is primarily fees and costs, but the average investor, five and a half or six percent. So they’re really…

CONSUELO MACK: Way underperforming.

MICHAEL MAUBOUSSIN: It’s way under the market and way under even the mutual funds in which they’re investing. As you point out, the reason for that is timing, bad timing. Right? So when things are doing well, people put money in. When things are doing poorly, people pull money out.

 

By the way, it is psychologically extremely difficult to counter this. I mean, if you think about what defines the peak of the market, those euphoric moments, March of 2000, it is everybody’s collective confidence in the future. Right? So every fiber of your body wants to be part of that. So that’s the definition of it. So the peak moment is when it’s hardest to actually do it, and then think of March of 2009 when the market is a low, and boy, everybody’s despondent, and every fiber in your body says sell. I want nothing more to do with this. So the key is to somehow counterbalance those things. Now, you can try to do it overtly and say, “Gee, everyone seems to be really happy or really freaking out. I’m going to try to take the other side of it,” or you can do something much more mechanical which is to say, “Hey, every month or every quarter I’m going to set aside X amount of dollars. I’m going to invest it in the market, and I’m going to sort of not worry too much about the actual prices.

 

CONSUELO MACK: So the dollar cost averaging.

MICHAEL MAUBOUSSIN: Dollar cost averaging, and these are ways to take some of the emotion out of the equation. That probably is another way that that can be helpful for investors.

 

CONSUELO MACK: Well, talk also about what you write about in your book, The Success Equation, which is the arc of skill, which is something that a lot of us don’t really want to hear about, but evidently there is an arc of skill in investing and in business and sports and everything else. So tell us about what it is in investing and how we can use that to our advantage.

MICHAEL MAUBOUSSIN: Now the arc of skill in physical tasks like athletics is pretty straightforward, right? So you get better as you get older, and you peak. For example, tennis players tend to peak around the age of 24, and then yeah, then you come down the other side which is not so… and different sports peak at different ages, but you’re right. The same process happens in cognitive tasks, and so we have this same sort of pattern of improving cognitively and then declining ultimately.

 

So there’s been some very interesting research on this. I’ll mention just two statistics. One was this is work done by David Laibson up at Harvard and some of his colleagues, and they studied at what age do people make the best financial decisions, and this would be the lowest interest rate on their mortgage or avoiding credit card fees and those kinds of things, and it turns out, with quite a bit of consistency across the different categories, the age was 53, and it turns out older people tend to have more wealth, but actually their decision making is not better. That’s the optimal. For investment managers…

 

CONSUELO MACK: So truly middle age is when you peak in investment decisions.

MICHAEL MAUBOUSSIN: Yeah. By the way, as a side note to that, older people actually tend to know all about investing. They know about diversification. They know about all the basic ideas, but often I guess they’re a little bit cognitively lazy, so they don’t actually go through the extra steps. Maybe there’s a better term, a more diplomatic term, but it’s basically cognitively lazy. For investment managers, they found the peak age of performance was in the early 40s which is actually a little bit younger than even for other financial decisions. Now, for any one individual, you should be very careful about extrapolating those numbers for any individual, but that’s what the academics have found when you look at large samples of large populations of investors.

 

CONSUELO MACK: And that’s very difficult, because you want to go with people who have experience, mutual fund managers and so an experience counts and performance counts and all of those things. So okay, so let’s try to figure out how we’re going to process that into our investment decision. So if there’s One Investment that we all should own some of in a long-term diversified portfolio, what would it be?

MICHAEL MAUBOUSSIN: I struggle with this, because I think today the most interesting anomaly that I see continues to be what is high equity risk premium. So in plain words, you think of a risk-free rate of return. In the United States, a 10-year Treasury note is a good proxy for that.

CONSUELO MACK: Supposedly, right.

MICHAEL MAUBOUSSIN: Yeah, and that’s today about a 1.8% yield. An equity risk premium is the return above and beyond that you would expect for taking on additional risk on equities. Now, over the long haul, that equity risk premium has been about three or four percent, something like that, and today, by most reckoning, it’s a lot closer to six percent. It’s very, very high. So to me, I don’t know if it’s bonds going down, in other words, yields going up because bonds going down, or stocks going up or some combination of these two things, but I have to believe, if you said to me three to five years what’s a good thing to bet on, I think it’s going to be that equity risk premium shrinking.

 

CONSUELO MACK: Shrinking.

MICHAEL MAUBOUSSIN: Shrinking, so it could be, again, because of bonds doing poorly, equities doing well or some combination thereof.

CONSUELO MACK: So what do we do with that information?

MICHAEL MAUBOUSSIN: Yeah, so I mean, go long equities would be one answer, but it’s really the relationship between equities and bonds I think is the most…

CONSUELO MACK: So go longer. Overemphasize stocks.

MICHAEL MAUBOUSSIN: Equities versus bonds.

CONSUELO MACK: And under… right. Underweight, underemphasize bonds. Michael Mauboussin, what a treat to have you on WEALTHTRACK. Thank you so much, and I want to ask you, will you stick around for an additional time with you for our website, for wealthtrack.com?

MICHAEL MAUBOUSSIN: It was great to be here and love to stick around. Thanks.

 

CONSUELO MACK: At the conclusion of every WEALTHTRACK, we give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is taken from investment legend, Vanguard founder and index fund pioneer John Bogle, a recent WEALTHTRACK guest. One of Bogle’s proven axioms is that costs matter. And Michael Mauboussin agrees, they do matter a lot! Every dollar you pay for your investment company’s overhead is a dollar taken away from your returns. So this week’s Action Point is: check out the impact costs are having on your portfolio.

 

Vanguard has an easy to use chart on its website. You start on the home page and go to “Insights” on the navigation bar and then click on the title “The Truth About Costs”. That’s where you can see the returns lost and the returns kept over different periods of time depending upon the expense ratio paid and the average annual return you are expecting. You can plug in whatever figures you are paying for a mutual fund you own and what the average annual return on that fund has been for different time periods ranging from one, to five, to 10, to 25 to even 50 year periods and find out how much you’ve kept and how much you’ve lost over the years. It’s an eye opener. Costs aren’t the only consideration in choosing a mutual fund, but they are a very important one.

 

If you would like to watch this program again, please go to our website wealthtrack.com. Premium subscribers can see future programs 48 hours in advance, and additional interviews with WEALTHTRACK guests are available in our WEALTHTRACK Extra feature. And that concludes this edition of WEALTHTRACK. Thank you so much for watching and make the week ahead a profitable and a productive one.

Premium: Michael Mauboussin

December 5, 20120 Comments

 

Investment Success Which Matters Most? Luck or Skill

Luck versus skill in investing! How much does each matter to investment success? Our guest this week, Financial Thought Leader Michael Mauboussin has written a new book on the topic. Titled The Success Equation: Untangling Skill and Luck In Business, Sports and Investing, its conclusions might surprise you.

Michael Mouboussin is the Chief Investment Strategist at Legg Mason Capital Management , as well as an award winning Adjunct Professor at Columbia Business School where he has taught Finance for the past 20 years.

In our never ending quest to identify the best investments, strategies and professionals to help you build long-term financial security, luck almost never comes up. Now it will! According to Mauboussin, luck plays a large role in investment success, but there are strategies to use both luck and skill to your advantage.

WEALTHTRACK Episode #924; Originally Broadcast on December 07, 2012

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[wptabs mode=”horizontal”] [wptabtitle]Guest Info[/wptabtitle] [wptabcontent]Michael Mauboussin
Chief Investment Strategist, Legg Mason Capital Management
Author, The Success Equation
[/wptabcontent] [wptabtitle] Newsletter[/wptabtitle] [wptabcontent]Consuelo MackAs we follow the on-again, off-again “Fiscal Cliff” negotiations between the White House and GOP House leadership, (tonight it’s on-again according to The Wall Street Journal) it occurs to us that if it weren’t so important to the future of the economy, our job and our investments we would tune the whole thing out. But it is important, so we remain captive to the rumors, reports and innuendos as does the market.

Who, if anyone, has an inside track to how the “Fiscal Cliff” saga will end? I have no idea, but I do know that Wall Street firms spend tens of millions of dollars a year trying to give themselves a competitive edge, which is why this week’s guest says it is so hard for professional investors to outperform the market and each other on a consistent long-term basis.

How much of a role does skill play and how much does luck really contribute to investment success? Those are the fascinating questions posed by this week’s guest in his new book, The Success Equation: Untangling Skill And Luck In Business, Sports And Investing.

He is Financial Thought Leader Michael Mauboussin, who is the Chief Investment Strategist at Legg Mason Capital Management, as well as an award winning adjunct professor at Columbia Business School, where he has taught finance for the past twenty years. He is also the author of several books, including More Than You Know: Finding Financial Wisdom  In Unconventional Places, which was named one of the best business books by Business Week magazine.

In our never ending quest to identify the best investments, strategies and professionals to help you build long-term financial security, luck almost never comes up. We along with everyone else are always focusing on measurable data such as performance, price, correlations, and economic and market trends. We also look at process such as a firm or fund’s investment approach, a manager’s analytical skills and investment discipline, and we pay attention to less tangible attributes, their professional standing, behavior through different market cycles and reputation for honesty and integrity.

But how do you figure luck into the equation, which according to Mauboussin, has a lot to do with investment success? We’ll find out in this week’s interview

As always, if you can’t join us at the appointed hour on your local public television station, you can watch the show on our website as a podcast or streaming video. You can also find the One Investment picks of our guests and my Action Points there. For those of you who would like to see our program 48 hours in advance of the broadcast, you can subscribe to our WEALTHTRACK PREMIUM subscription service on the website.

Have a great weekend and a Happy Hanukkah for those celebrating this weekend! Make the week ahead a profitable and a productive one!

Best regards,

Consuelo[/wptabcontent] [wptabtitle]Action Point[/wptabtitle] [wptabcontent]

Use Vanguard’s “The Truth About Costs” tool on their website –  you can see the returns lost and the returns kept over different periods of time depending upon the expense ratio paid and the average annual return you are expecting.

 

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[/wptabcontent] [wptabtitle]One Investment[/wptabtitle] [wptabcontent]MAUBOUSSIN: HIGH EQUITY RISK PREMIUM

Underemphasize bonds

“I struggle with this, because I think today the most interesting anomaly that I see continues to be what is high equity risk premium. So in plain words, you think of a risk-free rate of return. In the United States, a 10-year Treasury note is a good proxy for that. And that’s today about a 1.8% yield. An equity risk premium is the return above and beyond that you would expect for taking on additional risk on equities. Now, over the long haul, that equity risk premium has been about three or four percent, something like that, and today, by most reckoning, it’s a lot closer to six percent. It’s very, very high. So to me, I don’t know if it’s bonds going down, in other words, yields going up because bonds going down, or stocks going up or some combination of these two things, but I have to believe, if you said to me three to five years what’s a good thing to bet on, I think it’s going to be that equity risk premium shrinking… so it could be, again, because of bonds doing poorly, equities doing well or some combination thereof.

Yeah, so I mean, go long equities would be one answer, but it’s really the relationship between equities and bonds I think is the most… equities versus bonds.”
-Michael Mauboussin

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[/wptabcontent] [wptabtitle]Purchase DVD[/wptabtitle] [wptabcontent]Please check back for availability.[/wptabcontent] [wptabtitle]Archive[/wptabtitle] [wptabcontent]June 24, 2011

“Financial Thought Leader” Michael Mauboussin, Chief Investment Strategist of Legg Mason Capital Management, explains why its getting harder to beat the market and why doing less can actually make you more.

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