Karmanye vadhikaraste, ma phaleshou kada chana,
Ma karma phala hetur bhurmatey sangostva akarmani
This verse is from Bhagavad Gita, where Lord Krishna explains Arjuna to perform his duties, as the latter was not willing to fight the epic war of Mahabharata.
Karmanye vadhikaraste, ma phaleshou kada chana – You have the right to perform your actions, but you are not entitled to the fruits of the actions.
Ma karma phala hetur bhurmatey sangostva akarmani – Do not let the fruit be the purpose of your actions, and therefore you won’t be attached to not doing your duty.
In essence, Krishna asks Arjuna to keep on performing his duties without being attached to the result of his actions. “Forsake do-ership,” Krishna says. What Krishna tells Arjuna is encapsulated in the idea of Karma Yoga or the “discipline of action”. The word karma is derived from the Sanskrit kri, meaning ‘to do’.
Replace Lord Krishna with the likes of Warren Buffett, Ben Graham, Seth Klarman, or Howard Marks, and this is exactly what they have been teaching investors (the Arjunas) for years – focus on the “karma” – the process and action – and not the outcome.
Consider any field of activity where probabilities play a big role – the outcome is largely unknown – and research has identified a common trait amongst successful performers – they all emphasize process over outcome. Look at investing, and look around anywhere. Most investment experts selling their services always highlight the outcome – so much return in so many months or years – and never the process they used to get this outcome. This is simply because, while the outcome is there for everyone to see (availability bias), investors rarely ask the question whether that outcome was due to the skill of the expert (a proper investment process) or merely luck.
This is not to say that result (the phala) doesn’t matter; obviously it is important in measuring success. But if the result has been largely thanks to luck, it may not come in as expected in the future. What is more, if you focus only on the outcome, you are less likely to achieve it. Instead, if you focus on the process, the outcome will take care of itself.
Here is a small story I recently read which emphasizes why the right process can lead to a great outcome…
A giant ship engine failed. The ship’s owners tried one expert after another, but none of them could figure how to fix the engine. Then they brought in an old man who had been fixing ships since he was a young boy. He carried a large bag of tools with him, and when he arrived, he immediately went to work. He inspected the engine very carefully, top to bottom. Two of the ship’s owners were there, watching this man, hoping he would know what to do. After looking things over, the old man reached into his bag and pulled out a small hammer. He gently tapped something. Instantly, the engine lurched into life. He carefully put his hammer away. The engine was fixed!
A week later, the owners received a bill from the old man for ten thousand dollars.
“What?!” the owners exclaimed. “He hardly did anything!” So they wrote the old man a note saying, “Please send us an itemized bill.”
The man sent a bill that read:
Tapping with a hammer………………….. $ 2.00
Knowing where to tap…………………….. $ 9,998.00
So, knowing where to tap – the process – makes all the difference…whether you are working with a hammer or with your money. Over the long term, a good process delivers highly desirable results, and generates better and more reliable outcomes. This isn’t any secret.
If you were observing Michael Phelps, the swimming legend, compete against few amateur swimmers, even few observations would be enough to make a generalization about future outcomes of such competitive events i.e., Michael Phelps will trounce each one of them every single time. Here you don’t need to worry about the law of small numbers. Why?
The answer lies in understanding the role of skill and luck in any activity.
The magnitude of the fallacy grows larger as the luck-to-skill ratio rises. Be it sports or investing, a lot in our life is governed by luck. Certain games (cricket or poker) have higher element of luck and some are completely devoid of luck (chess or swimming). So an amateur player can win a game of poker a few times just because of luck, but over a longer period of time i.e., over a large number of hands played, the luck evens out and skill prevails. A corollary to our law of small numbers would be – over short periods of time, luck is more important than skill. The more luck contributes to the outcome, the larger the sample you’ll need to distinguish between someone’s skill and pure chance.
For that matter, how to determine if an activity is ruled by luck or pure skill?
Michael Mauboussin, in his book “The Success Equation” writes that much of what we experience in life (and investing) results from a combination of skill and luck.
This is an extremely important and interesting subject. Often it is hotly debated whether luck is prevalent or skill. The answer lies somewhere in between and is a combination of luck and skill. It’s like marriage. One would be lucky to get a good wife, but one has to be skillful so that she remains good to you! J
Success is a matter of luck as well as skill. However, the percentage of both differs in different situations. The story I would like to talk about skill and luck is that of Sachin Tendulkar. There is absolutely no doubt that his success comes from his tremendous attitude towards the game. It is not just skill or luck. Very clearly, he was lucky that his parents, like typical Maharashtrians did not ask him to stop playing cricket in eighth standard and instead concentrate on Maths and Physics. That is sheer luck that they allowed him to play cricket. Then, the fact that he was playing in Shivaji Park (a large and centrally-located park in Mumbai) and everybody could see him was luck. If he were playing somewhere in the outskirts of Mumbai or in some small town, nobody would have spotted him at 16. People would have spotted him at 21, like it happened to Mahendra Singh Dhoni. But it wouldn’t have happened at 16. So he got spotted then, and that is luck. He had skill, there is no doubt about it. After that, it was all about his attitude. When he was playing, if he had to reach the practice session at 9 AM, he would reach there at 8.30, finish his warm up and be ready to take strike at 9, and not reach at 9. That was attitude, because after you have Rs 1,000 crore net worth, you need not do it. But he was still doing it. So it’s a combination of skill, luck, and attitude. You need skill, but you also need luck.
Currently there are three formats in cricket, T-20, One Day & Test Match. We can clearly see that in T-20 it’s more about the luck on particular day than the skill that actually prevails. As the time horizon increases it’s the skill that dominates rather than the luck. So the time frame of the success period is instrumental in determining whether it’s because of sheer luck or is it the fruit of real skill & talent.
There’s also a simple and elegant test proposed by Michael Mauboussin in his book, The Success Equation, which is to ask whether you can lose on purpose. If you can’t lose on purpose, or if it’s really hard, luck likely dominates that activity. If it’s easy to lose on purpose, skill is more important.
This has huge implications not only in sports but in investing too. David Einhorn, billionaire hedge fund manager and author of Fooling Some of the people all the time, explains –
People ask me “Is poker luck?” and “Is investing luck?”
The answer is, not at all. But sample sizes matter. On any given day a good investor or a good poker player can lose money. Any stock investment can turn out to be a loser no matter how large the edge appears. Same for a poker hand. One poker tournament isn’t very different from a coin-flipping contest and neither is six months of investment results.
On that basis luck plays a role. But over time – over thousands of hands against a variety of players and over hundreds of investments in a variety of market environments – skill wins out.
People who are new to a game of casino and lose in the first few rounds are usually clever enough to fold. But whoever strikes lucky tends to keep going. Convinced of their above-average skills, these amateurs increase the stakes—but they soon will get a sobering wake-up call when the probabilities “normalize.”
Beginner’s luck plays an important role in the economy: Say company A buys smaller companies B, C, and D one after the other. The acquisitions prove a success, and the directors believe they have real skill for acquisitions. Buoyed by this confidence, they now buy a much larger company, E. The integration is a disaster. The merger proves too difficult to handle, the estimated synergies impossible to realize. Objectively speaking, this was foreseeable because in the previous acquisitions everything fell perfectly into place as if guided by a magical hand, so beginner’s luck blinded them.The same goes for the stock exchange. Driven by initial success, many investors pumped their life savings into Internet stocks in the late ’90s. Some even took out loans to capitalize on the opportunity. However, these investors overlooked one tiny detail: Their amazing profits at the time had nothing to do with their stock-picking abilities. The market was simply on an upward spiral. Even the most clueless investors won big. When the market finally turned downward, many were left facing mountains of dot-com debt.
We witnessed the same delusions during the recent U.S. housing boom. Dentists, lawyers, teachers, and taxi drivers gave up their jobs to “flip” houses—to buy them and resell them right away at higher prices. The first fat profits justified their career changes, but of course these gains had nothing to do with any specific skills. The housing bubble allowed even the most inept amateur brokers to flourish. Many investors became deeply indebted as they flipped even more and even bigger mansions. When the bubble finally burst, many were left with only a string of unsellable properties to their names.
But how to difference between luck and signs of real talent/skill? There is no clear rule, but these may help: First, if one is much better than others over a long period of time, one can be fairly sure that talent plays a part. (Unfortunately, you can never be 100 percent, though.) Second, the more people competing, the greater the chances are that one of them will repeatedly strike luck. But if one is top dog among ten million players (i.e., in the financial markets), one shouldn’t start visualizing a Buffettesque financial empire just yet; it’s extremely likely that one have simply been very fortunate.
Why are there so few serial entrepreneurs—business people who start successful companies one after the other?
Serial entrepreneurs account for less than 1 percent of everyone who starts a company. Do they all retire to their private yachts after the first success just like Microsoft co founder Paul Allen did? Surely not. True business people possess too much get-up-and-go to lie on a beach chair for hours on end. Is it because they can’t let go and want to cosset their firms until they turn sixty-five? No. Most founders sell their shares within ten years. Actually, you would assume that such self-starters who are blessed with talent, a good personal network, and a solid reputation would be well equipped to found numerous other start-ups. So why do they stop? They didn’t stop. They just failed at succeeding. Only one answer makes sense: Luck plays a bigger role than skill does. No businessperson likes to hear. At first, it sounds a little offensive, especially if you worked hard to get there.
Let’s take a sober look at business success: How much of it comes down to luck, and how much is the fruit of hard work and distinct talent? The question is easily misunderstood. Of course, little is achieved without talent, and nothing is achieved without right work. Unfortunately, neither skills nor toil and trouble are the key criteria for success. They are necessary—but not sufficient. How do we know this? There is a very simple test: When a person is successful for a long time—more than that, when they enjoy more success in the long run compared to less qualified people—then and only then is talent the essential element. This is not the case with company founders; otherwise, the majority of successful entrepreneurs would, after the first achievement, continue to found and grow second, third, and fourth start-ups.
What about corporate leaders? How important are they to the success of a company? Researchers have determined a set of traits deemed to be associated with “a strong CEO”—management procedures, strategic brilliance in the past, and so on. Then they measured the relationship between these behaviours, on the one hand, and the increase of the companies’ values during the reign of these CEOs, on the other hand. The result: If one compares two companies at random, in 60 percent of cases, the stronger CEO leads the stronger company. In 40 percent of the cases, the weaker CEO leads the stronger company. This is only 10 percentage points more than no relationship at all. Kahneman said:
“It’s hard to imagine that people enthusiastically buy books written by business leaders who are, on average, only slightly better than the norm.”
Even Warren Buffett thinks nothing of CEO deification:
“A good managerial record . . . is far more a function of what business boat you get into than it is of how effectively you row.”
In certain areas, skill plays no role whatsoever. In his book Thinking, Fast and Slow, Kahneman describes his visit to an asset management company. To brief him, they sent him a spreadsheet showing the performance of each investment adviser over the past eight years. From this, a ranking was assigned to each: number 1, 2, 3, and so on in descending order. This was compiled every year. Kahneman quickly calculated the relationship between the years’ rankings. Specifically, he calculated the correlation of the rankings between year 1 and year 2, between year 1 and year 3, year 1 and year 4, up until year 7 and year 8. The result: pure coincidence. Sometimes the adviser was at the very top and sometimes the very bottom. If an adviser had a great year, this was neither bolstered by previous years nor carried into subsequent years. The correlation was zero. And yet the consultants pocketed bonuses for their performance. In other words, the company was rewarding luck rather than skill.
In conclusion: Certain people make a living from their abilities, such as pilots, plumbers, lawyers etc . In other areas, skill is necessary but not critical, as with entrepreneurs and leaders. Finally, chance is the deciding factor in a number of fields, such as in financial markets. Here, the illusion of skill pervades. Moreover good process may not always lead to good outcome or good outcomes may not always be result of good process. But if one focuses only on the outcome, one is less likely to achieve it. Instead, if one focuses on the process, the outcome will take care of itself.
Wisdom platter 