risk, luck and naiveness — Tarik Yildirim

If risk is what happens when you make good decisions but end up with a bad outcome, luck is what happens when you make bad or mediocre decisions but end up with a great outcome. They both happen because the world is too complex to allow 100% of your actions dictate 100% of your outcomes. They are mirrored cousins, driven by the same thing: You are one person in a 7 billion player game, and the accidental impact of other people’s actions can be more consequential than your own... Risk doesn’t care about how much effort you put into something, and neither does luck. Both just show up, unannounced, eager to humble you. The only difference is that risk humbles you as soon as it arrives, while luck humbles you down the road, once it vanishes, leaving you with only the memories you shared together.

Morgan Housel - Ironies of Luck

Let us define people who believe that all good outcomes come from good decisions and all bad outcomes come from bad decisions as naive.

Naive and lucky people (people who are lucky but do not know that they are lucky) systematically overestimate the upside potential of their good decisions because they can not see that a portion of their good outcomes are coming from their bad decisions. Consequently they feel like they can take bigger risks. At some point their luckiness can no longer compensate for their increased risk taking and their returns collapse back to a state of normalcy where they either make big gains or big losses.

Naive and risk taking people (people who take risk but do not know that they are taking a risk) systematically overestimate the downside potential of their bad decisions because they can not see that a portion of their bad outcomes are coming from their good decisions. Consequently they feel unlucky. They scale back their risk taking behavior and their returns collapse back to a state of normalcy where they either make small gains or small losses.

So you need to know thyself and shed your naiveness away in order to sustain the positive returns due to luck or risk. (Remember that each person tends to be naive in a different way.)