Luck Has a Lot to Do With It

I seem to be on a niceness streak lately. Yesterday brought another item written by somebody other than me which I nevertheless liked. Try as Investors Might, So Much Depends on NYSE-Mod-SmallChance, from The Wall Street Journal, tells us that a person’s lifetime of investment returns is dependent primarily on  accidents of birth rather than skill.

We spend a lot of time wrestling with investment selection angst. This mutual fund or that one, active or passive, 20% in bonds or 50% in bonds, and so on. Those are important and hard questions, but there is a forest-for-the-trees danger here.

The biggest driver of long-term investment returns is not an investor’s skill but the overall market returns over the period. In other words, whether you wind up living large or living modestly at 70 is largely luck.

Of course there are other factors. How much you save is an obvious one. And there are plenty of opportunities for acting foolishly in a way that will jeopardize your retirement. But for most people, what the market returns over a relatively short period, the 20 or 30 years before retirement, is the single biggest determinant of retirement wealth.

Consider somebody born in 1916 who turned 65 and retired in 1981. In the 20 years before his retirement the stock market averaged a return of only 6.57%, just 1.07% ahead of inflation over the same period. $100,000 invested in the market on his 45th birthday would have been worth $357,026 at 65.

Now consider someone born 17 years later, in 1933. Over the 20 years before his retirement in 1998 the market averaged 17.32% a year. (That happened to be its best 20 year period since 1890.) $100,000 invested on the last day of 1978 would have grown to $2,440,288.

The difference between $357K and $2.4M is tremendous in terms of retirement wealth and lifestyle. And yet all that separates these two people is the year in which they were born. And those years are not even that far apart. The 20 year investment periods actually overlap.

Individual investors often cheer themselves with the observations that a) the stock market has gone up by more than 10% on average for more than a century and b) although it is volatile, by holding on over decades a person can get closer to the long-run average return.

Those observations are not wrong, exactly, but their import is easily exaggerated. That the US stock market has gone up double digits on average over the past 120 years is a factually correct statement of history, but it does not necessarily follow that going up an average of 10% a year is part of the inherent nature of the market.

And investing over 20 years is less risky than investing over a shorter period, in a way, but it is not diversifying in the conventional sense. Putting all your money in a single stock for 20 years is not like putting a twentieth of your money in each of 20 stocks for one year.

In the 20 stock portfolio case your total return will be the average of the stock returns, that is, the sum of each return times 5%. If one goes down 50%, your portfolio is down only 2.5%. But the 20 annual returns from the single stock do not get averaged, they get multiplied. If one year is down 50%, your 20 year return is half what it would have been otherwise.

I still think the stock market is the single best asset class available for long-term investing and that spending the time to select the best form of that investment is important. But it is also important to realize that, like many things in life, in this respect our control over our destiny is limited.


  • By Mr.GoTo, August 3, 2010 @ 12:15 pm

    While conceding that “investing in stocks over 20 years is less risky than investing over a shorter period” is the prevailing “wisdom”, I respectfully ask: Where is the evidence that supports this belief?

  • By Dan, August 3, 2010 @ 1:08 pm

    In other words, it’s the retirement/investing version of Malcolm Gladwell’s Outliers. A financially successful retirement can’t happen without preparation and discipline, but a truly prosperous retirement is largely the result of circumstances that are beyond our control – indeed that may be no more than luck or happenstance.

    So in short, if you want to be sure, save like crazy because investment returns may not do it for you. Then if the returns do come in, that much the better.

  • By jb, August 3, 2010 @ 1:44 pm

    Something doesn’t seem right about your comparison of the two investors. The $100,000 that each invested is not equivalent, because of the time value of money. 20 years of inflation would have skewed things even more.

    But your point is still completely valid about being lucky with respect to investment returns. The same thing applies to succes in your career. Graduating at the wrong time can play havoc with your career path and salary.

  • By Doug Stalnaker, August 3, 2010 @ 2:12 pm

    Given all this evidence and you STILL recommend investing in the market?! People should only invest in stocks what they can afford to lose.

  • By sha, August 3, 2010 @ 2:42 pm


    The value of 350k vs 2.4 million in the respective time periods is irrelevant. If the %’s were switch at the beginning, the 350k guy would be the 2.4 million guy. This is completely a numbers thing with $ signs tossed in for fun.

  • By Josh, August 3, 2010 @ 3:58 pm


    The point of Frank’s post also applies to any other asset category. Any type of investment will have varying returns over time, and your end result will depend on whether you pull your money out during a peak or a trough.

  • By Frank Curmudgeon, August 3, 2010 @ 4:50 pm

    Mr. GoTo: I suppose it might depend on what you meant by risky. What I had in mind was the simple mathematical truth that if X% is the expected value of stock market returns, you are more likely to hit that target in terms of your annualized return the longer you hold on. Of course, you might argue that annualized returns are not what counts. In terms of dollars of wealth, the longer you invest the wider the distribution around your expected value.

  • By bex, August 3, 2010 @ 6:06 pm

    Frank: but wouldn’t those numbers be a bit closer together if these two folks used the dreaded “dollar cost averaging” strategy?

    Instead of $100k in one lump sum at age 45, how about $5k each year from 45 to 65? Or, from 35 to 55, with 10 years of waiting? It would probably be less money for the $2.4M dude…

  • By Mr.GoTo, August 3, 2010 @ 6:21 pm

    Frank: I used to buy into the “stocks are safer over the long run” theory until I started reading the research from Prof. Zvi Bodie. His important conclusion about the prevailing wisdom is this: “The basis for the proposition that stocks are less risky in the long run appears to be the observation that the longer the time horizon, the smaller the probability of a shortfall. But as has been shown in the literature, the probability of a shortfall is a flawed measure of risk because it completely ignores how large the potential shortfall might be.” His debates with Jeremy Siegel on this topic are very interesting and highly recommended for the long term investor.

  • By Lance, August 3, 2010 @ 6:45 pm

    Mr.Goto– What does he suggest instead? Bonds?

  • By Guzzo, August 3, 2010 @ 8:44 pm

    Heck, just “living” to 70 requires a good bit of luck. I worked with an unfortunate pharmacist whom worked hard his whole life, saved and invested wisely, and was on the brink of enjoying a wealthy retirement, including two separate pensions.

    In the week before he was to retire, he had a heart attack at work (in a hospital ironically) and passed away. Poor guy, he never got to enjoy the fruits of his labor.

  • By Craig, August 3, 2010 @ 10:31 pm


    I think there’s profound wisdom in what you say. I’ve been coming around to Jim Otar’s thesis that luck–in the sense of when you were born–is the single most important factor in determining investment outcome. Don’t know if you’re familiar with his work ( I’m working through his e-book “Unveiling the Retirement Myth” in fits and starts. It’s pretty heavy sledding sometimes, and you have to translate from the original Canadian in your head, which is always a hassle, but it’s taught me a lot.

    Otar’s basic method is to evaluate strategies by seeing how well they would have worked for someone in each of the last hundred years or so, using real market returns that have included Depression, Stagflation, the Affluent Society, Internet Bubbles, and everything in between. You plot a hundred different returns on a graph together, and look at not only the “median” case, but also the “unlucky” ones. (The “lucky” ones are okay for daydreaming, but not for planning.)

    This comes from an engineering truism: you can’t design for “average” conditions. A building designed to withstand “average” winds will fall over in the first stiff breeze. So will a retirement plan counting on “average” returns. Otar instead wants a portfolio that will outlive him in 90% of historical scenarios. This leads to some hard decisions, like moving the traditional 4% initial withdrawal in retirement down to about 3.1%. Gulp! Now I need 33x my initial withdrawal, not 25! Or I need to annuitize my retirement. Or both.

    This newfangled concept that every middle-class Jack and Jill is going to become a “capitalist” late in life–in the sense of living off investments rather than wages–is a radical and unproven paradigm. I simply don’t think it has a chance of ever working for the vast multitude. I’m fairly smart, good with numbers, and I care about this stuff–and even _I_ don’t know if I have much of a handle on it. I guess we’ll all see how it goes.

  • By Frank, August 4, 2010 @ 9:40 am

    Can you run the numbers for someone investing per month or per pay period, rathing that one large lump sum?

    How much does that effect the outcome?

  • By Sam, August 4, 2010 @ 12:13 pm

    If a person doesn’t take money from the government because they don’t “need” it, they are basically saying that the government knows how to use their money better than they do for (1) their benefit or (2) other people’s benefit. If you think (1) is true, that’s sad. If you think (2) is true, you are basically donating your money to the government for pretty much the same reasons you would donate it to charity. Which leads to an interesting question – If the government is just a big charity, should you be able to deduct you income tax from your income tax? (Just imagine the iterative tax nightmare that could create.)

  • By Frank Curmudgeon, August 4, 2010 @ 1:06 pm

    Bex: You are deliberately trying to bait me, aren’t you? I know you’ve read what I have to say about dollar cost averaging. Others might want to plug it into the search box at right.

    Mr. Goto & Craig: It seems to me that this is as much an issue of expectations than anything else. 10% return may be a perfectly correct estimate for the long-run annual returns to stocks. The problem is in understanding what that means. The average outcome is itself not very likely. I am not sure that asset allocation needs to be different with a better understanding, but many people could use a significant adjustment in their expectations. A 45-year-old really can’t “plan” for a certain retirement lifestyle. He can only aim, fairly inaccurately, for one.

    Other Frank: One lump investment at 45 is a simplification of many years of investing from, say, 35 to 65. I could run the numbers, but it would be a bother and would get basically the same result. I’ll bet you could work it out too.

    Sam: I’m confused.

  • By Sam, August 5, 2010 @ 11:37 am

    When I say “you”, I mean “everyman”, not you personally. Sorry for the confusion.

  • By Sam, August 5, 2010 @ 11:42 am

    Additional, I somehow posted my comment to the wrong article. My comment should make more sense with respect to “Millionaires on the Dole”

  • By slacker, April 29, 2011 @ 5:16 am

    Good post , I am going to spend more time reading about this subject

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