Book review: The Success Equation

by Michael Mauboussin

Summary/description

Let me declare at the outset that I would recommend this book to anyone engaged in a career/domain where luck plays a role in the outcome of success. The book is a multidisciplinary inquiry on luck and skill, explaining why we should all critically think about how much luck and/or skill matter in the endeavors we pursue. The author draws on a wide range of disciplines to illustrate his points, utilizing key concepts from sports, statistics, mathematics, decision-making, psychology, philosophy, and many more.

Michael Mauboussin (MM) repeatedly uses a concept, the ‘luck-skill continuum’, which places sports closer to the skill side of the spectrum and investing closer to the luck side. He argues that in domains where luck plays a limited role, deliberate practice, practice which is cognitively demanding where you can obtain immediate feedback on how you did and what to improve on, can rapidly improve your skills in that domain. David Epstein would call such domains a ‘kind environment’, where there are no feedback loops and no path dependence (where one action affects the next action and so on). In contrast to ‘kind’ environments, ‘wicked’ environments do not provide a training ground where feedback is easily obtained. In investing, for example, the environment is dominated by luck, especially in the short term. Whether a stock you bought goes up or down in the next 12 months is largely a matter of luck, it follows also that stock price movements cannot be predicted consistently and successfully.

Thoughts and takeaways

            There are many interesting examples in the book, MM masterfully showcases his broad range of knowledge and deep research into 3 topics, sports, businesses, and investing. takeaways that I focus on, there are many more lessons to be learned, I show just the key ideas I got from the book, for interested readers out there please read the whole book as my summary here does not do the book justice.

A very important part of the book, where MM discusses how to use statistics to determine where activity is situated in the luck-skill continuum, is only loosely explained here. It is quite a complex topic to get across, I cannot find the right words at the moment to articulate the points well (which shows that I do not understand the topic well enough). In essence, MM argues that you have to develop useful metrics to measure performance and many people focus on the wrong things. For a statistic to be useful, there are 2 requirements. First, persistence. Persistence means what happens in the present is similar to what happened in the past. How valuable is your data in helping you predict what is going to happen next. Second, predictability of a statistic

MM explains that where cause and effect are clear (luck plays a limited role), deliberate practice and checklists help tremendously. However, where the line between cause and effect is blurred, even if you do everything right, the outcome may still be bad. That is when it is important to focus on the process. MM states that a skillful process involves 3 things, he uses an example from investing:

(1)  Analysis

For traders and investors out there, this is your fundamental research. The first step of a good investment process is your analysis of the merits of an investment. How much a company is going to earn, what is the value of the assets, why an opportunity exists?

(2)  Psychological factors

The 2nd step involves psychological factors, where you check your own biases and heuristics. Key questions to ask are:

·         Am I overweighing positive evidence and neglecting negative evidence about the company?

·         Am I putting too much emphasis on the recent news of the company, whether the company had a good and bad quarter?

·         What is my plan when the stock goes down? Kahneman and Tversky developed the idea of prospect theory, where losses hurt more than winners. (We suffer roughly two times more from a loss than we enjoy a gain of the same size). This is evident in investors as they refuse to cut loss and take small profits, which is the anathema of spectacular investment results

(3)  Organizational behavior (Inapplicable for retail investors)

In the final chapter of the book, MM gives 10 lessons on the art of good guesswork (synonymous with good decision-making). An important lesson is the practice of making reversion to the mean your friend. Knowing about this mental model, which states that extreme outcomes tend to revert to the mean, to use his lively example, a group of students scoring in the top 0.1 percentile is unlikely to score the same in a similarly difficult test the next time. Finally, an important lesson from MM is how we should understand our limitations. Daniel Kahneman, the Nobel prize pioneer of the heuristics and biases approach has said that even after a lifetime of training he could not train himself out of his biases. Not all activities can be accurately predicted, the importance is to develop a mindset to think about an activity, to know its place in the luck-skill continuum.

Conclusion

Readers who enjoyed Daniel Kahneman’s works, Nassim Taleb’s works, and general decision-making (which all investors should be interested in) will be utterly fascinated by the examples he utilizes. A 10/10 great read, although the statistics that he uses can get complicated pretty easy for the mathematically illiterate (me).