The Market Is Not A Casino

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It’s not our fault that we think of the stock market as a form of speculation. Pundits and consumers alike refer to investing as “playing the market,” as though we’re walking up to a blackjack table, slot machine or roulette wheel. And just like gambling, participating in the stock market comes with risk.

Growth in the market is not guaranteed. (The “G” word is important.) But, unlike a casino, where the odds never favor the players, the odds of succeeding in the stock market are pretty darn good. 

For example, here are the odds of winning some popular casino games:

• Roulette: < 47%the

• Texas Hold ‘Em:  < 20%

• Craps: < 17%

Even with slot machines, “the house” (that is, the casino) has the edge over the player. And make no mistake, it always has the edge.

Unlike a casino, the stock market—specifically the S&P 500 Index—has been positive 73.5% of the time since 1926, the year we credit as the start of the “modern market.” And when it’s up, the average positive return is 21.4%. During the 26.5% of the time the market ends the year down, the average negative return is -13.4%. And over the long term, the overall average (geometric) return of the market is 10.3%. (D. Blanchett, Morningstar Data.)

Those numbers look great, don’t they. Three quarters of the time, the stock market will make us money. And, when it makes us money, it makes more money than what we lose in “down” years.

That leads me to the following question: Why does the stock market make us queasy? 

Why do we think there’s more risk than actually exists? Well, it turns out there’s a host of psychological reasons and biases that get in our heads and undermine our rational behavior; emotional triggers that make us flinch, not the least of which is the news cycle, which treats a single day’s volatility like a blue-moon event.

Remember, they (the biz media) want to keep your eyes on their content, so of course they’re going to be dramatic. What’s more, they want you to trade the new, hot item because “holding” stock isn’t sexy enough. Business newscasts provide edutainment (sigh), and that’s why you’ll rarely hear them tell you to “stay the course.” It would be bad for their business.

Here's one example of irrational fear: It’s not uncommon to be caught up in “recency bias,” wherein we think the most recent market behavior is the only one that will repeat into the future. This happens both with up and down markets. The most recent market year is a great example. The market was down for the first 10 months of 2023, and no amount of positive economic news could budge it. But, come November and December, the market recovered and ended the year brilliantly.

Nobody would blame us if we were skittish for 10 months, thinking the market would never recover. And yet, it did. So now, everyone thinks the market is fabulous and we should all jump in, promptly forgetting about January through October of 2023.

Our job is to be patient and understand that the words “over time” truly mean over time.  We should not ask for—nor should we expect—immediate improvement of our portfolio. If we choose a proper portfolio with high-quality funds or stocks, we will prevail in the long run.

Over. Time.

Let’s return to the word “guarantee,” which represents the other end of the spectrum from risk. If we expect greater reward to come with greater risk, what should we expect to come with a guarantee? Simple answer: a lesser reward.

Financial instruments (savings accounts, certificates of deposit, treasury bills, bonds, etc.) that provide a guarantee of income produce a lesser reward than the stock market. Can we achieve our financial goals without taking market risk? Yes, we can. But we have a tradeoff for this approach because we introduce three new factors: inflation risk, liquidity risk, and interest rate risk.

Inflation risk is the risk that our instrument won’t beat the rate of inflation, and our assets will buy less and less over time. That’s not good. It means we’d have to contribute more to achieve the same result.

Liquidity risk is the risk that, to achieve the guarantee, our money isn’t available to us to use. That’s not always a problem, but sometimes it is.

Interest rate risk is the risk that, when a particular instrument matures, we will not be able to renew it at the same or better interest rate.

So, we have a choice: accept some market risk for a great return over time (but not immediately) or accept no market risk but incur other risks which could impact our financial goals. If you’re asking me, I would choose the market risk, especially when the time horizon (runway) is long enough for lots of doubling (not to be confused with “doubling down” like in blackjack).

But who says it’s a “one-size-fits-all” proposition? Why can’t we expose some of our money to market risk, some to liquidity risk with a guaranteed return, and some to other acceptable risks? In other words, we can diversify the risk over different financial instruments. 

Well look at that, Maybelle, when we do that, we have ourselves a diversified asset portfolio!

We would all be well-served if we understood that the goal for our later-life nest egg is investment and staying the course, not speculation. Speculation is for entertainment.  It’s your casino money. When a client wanted to “take a flyer” on a stock, my response would be to segregate that money from what they’d earmarked for financial goals.

For our retirement portfolio, let’s avoid “rolling the bones” and embrace investment to keep the odds in our favor. #WeRescueOurselves

Reading:

David Blanchett, CFA®, CFP®,  Stocks for the Win  including Morningstar Data

“What Are The Odds?” casino.org

© 2024 Madrina Molly

The information contained herein and shared by Madrina Molly™ constitutes financial education and not investment or financial advice.

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