The difference between risk and luck in investing...

Luck and risk are two sides of the same coin. It’s impossible to grasp one without understanding the other.

We typically define risk in terms of questionable decisions that can lead to bad results. Luck, meanwhile, is when questionable decisions lead to good results.

The concepts of risk and luck exist because our actions cannot determine 100% of our outcomes. In a world with almost eight billion people, the impact of others’ choices on us can be far greater than our own.

Risk forces us to recognize that certain things are outside of our control. This information informs our decision-making so we can make appropriate adjustments. Experiencing good fortune has the opposite effect: luck tricks us into thinking we’re in control, which is dangerous.

When it comes to investing, recognizing and managing risk are considered hugely important. The same can’t be true about luck. This is why you’ve never heard of a luck consultant. There’s no requirement to disclose lucky breaks in financial reports. It’s a double standard.

The reason we discount luck is because we’re wired to identify patterns of what works. The prospect of cracking some secret formula and being able to repeat it for future gains is an irresistible narrative. Luck stokes our ego and makes sense of chaos.

A good investor should account for luck as much as risk. VCs, for example, operate under the assumption that about 50% of all investments will fail. By factoring in the role of luck (success that is not structurally repeatable) you’ll be better equipped to navigate uncertainty.

When the going is good, people tend to minimize the amount of risk and luck involved equally. The difference is that when risk halts your winning streak, it’s instantly clear what went wrong. It takes us much longer to see the role that luck played.

Risk can harm confidence in decision-making, even though the outcome is simply clarifying reality and guiding you towards more informed choices. Luck boosts confidence without improving ability, setting off a vicious cycle where we leave no room for error and ignore luck's role.

Being aware of risk and luck empowers you to recognize that you can’t control everything. This frees you up to focus on the few things you can control. Whether you learn to manage risk and luck, or choose to ignore them, what you can’t do is avoid them.