Aswath Damodaran: The Role of Luck, Diversification, and Hubris in Investing

Johnny HopkinsAswath DamodaranLeave a Comment

In this interview with Morningstar, Aswath Damodaran discusses how luck plays such a dominant role in investing, and it’s impossible to eliminate it entirely. The key is to reduce exposure to luck by diversifying investments and maintaining humility. Damodaran advises that investors should recognize that their efforts may only slightly improve their odds of success, not guarantee a near-certain outcome, as unexpected surprises in the world can still affect investment results. Here’s an excerpt from the interview:

Damodaran: It shows up in two ways. One is you spread your bets, I’ve never understood people who concentrate their investments in four or five companies.

Because you can have the probabilities in your favor but luck is such a dominant paradigm in this business that you can be right and go bankrupt being right.

So hubris is the biggest enemy of good investing because hubris is when you say look I have worked out the probabilities.

They’re in my favor. Therefore I’m going to load up on these three or four, or one company because I feel I’m going to be right.

So luck in fact is the dominant paradigm here and you cannot make it go away but you can reduce your exposure to it by spreading your bets and being humble.

Saying look I’ve done my valuation. I’ve invested in it. All you’ve done is altered the odds of success from 50% to 52%. Not 50 to 95%. And that’s what you need to think about here.

You can do everything right but you cannot control what the world will deliver as surprises.

You can watch the entire discussion here:

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