While many investors concede that it is difficult to outperform the market over an extended period of time, Spencer Jakab argues it is even more challenging to tell if those select few who manage to beat the market are more skilled or just lucky.
You will need a WSJ subscription to be able to read the entire article. I have included the part of the article I found most interesting below. I think the excerpt demonstrates that we often underestimate how much data we need to prove the difference between two data sets is statistically significant.
While it isn't always feasible to get complete information before making a decision, it is important to realize that you are acting on incomplete information rather than being fooled by randomness. I hope this article will make you think twice about paying hefty management fees for a fund manager that has outperformed the market over the last 1-3 years.
He and two colleagues told several hundred acquaintances who worked in finance that they would flip two coins, one that was normal and the other that was weighted so it came up heads 60% of the time. They asked the people how many flips it would take them to figure out, with a 95% confidence level, which one was the 60% coin. Told to give a “quick guess,” nearly a third said fewer than 10 flips, while the median response was 40. The correct answer is 143