The stock market is NOT a casino

It is not often that I find myself disagreeing with anything that our beloved and dreaded Supreme Dark Lord (PBUH), Voxemortus Malevolus, has to say. But he has made a comment on at least two separate occasions in his Darkstreams which, in my personal opinion, merits some attention.

He has stated on a couple of occasions, most recently in a Darkstream concerning Uber's recent IPO, that the stock market is just a casino, and that investing in it is folly.

A careful examination of the evidence shows that, when done correctly, stock investing is anything but a casino and is in fact the single best driver of stable, solid long-term returns.

First, let us grant the Supreme Dark Lord (PBUH) all possible benefit of the doubt.

If you insist on day-trading, or on investing in the latest crazy IPO like Uber or Snapchat or any other "hot" stock where the underlying company makes no profits whatsoever and has absolutely no plan whatsoever to do so anytime soon, then you are gambling.

If you are investing "on margin", which basically involves leveraging your cash in your brokerage account, then you're doing exactly what the banks do when they take every dollar that you've deposited with them in your checking account, and then loaning out thirty dollars against that single solitary greenback to borrowers who may, or may not, pay that money back.

If you are trading options, and you have no clue how an option works or how the underlying mathematics operates, then you're playing poker with a face that can be read like a book.

If you put your money into the market, lose it all, and then double down on your bet because you are emotionally attached to a particular stock, then you are adopting a strategy known as the "Gambler's Ruin", and you will end up ruined. It's a mathematical certainty.

If you are putting money into the stock market that you cannot afford to lose, then you are likely too stupid to reproduce, let alone invest.

And if you are chasing hot stocks based purely on hype, as I indicated above, without paying any attention whatsoever to fundamentals, then do us all a favour and follow these exact steps:

1. Raise your hand, palm facing you, to your face.
2. Hit yourself in the forehead, REALLY HARD.
3. Repeat this anywhere from 10 to 100 times, depending on severity of condition

Anyone who does any of these things is an infinite degree of idiot. That approach to putting money in the market is likely to be more damaging to it than simply setting it on fire. At least if you set your money on fire, you know it's going to be destroyed - whereas, if you plonk it into the stock market, you will always have this hope that things will turn out all right.

This post is not for the idiots.

This post is for the people who want to learn how to make almost guaranteed money in a slow, steady, risk-adjusted, careful way, with a long time horizon that will yield tremendous rewards much later down the line.

Before I continue, I have to make some disclaimers, for legal reasons.

I am not an investment advisor of any kind. I do hold positions in S&P 500 index funds, as well as a number of Wisdom Tree ETFs - including their High Yield Dividend ETF, for both US and international stocks - and I hold positions in a (small) number of US blue-chip companies as well.

What I'm about to show you should in no way be construed as investment advice. All investments come with risks. Some are small, like investing in AAA-rated blue-chip companies with so much cash on hand that their banks are practically screaming for a chance to lend them money. Other risks are quite huge, like investing in companies which do make profits but burn through billions of dollars of cash every year just to produce new content (*cough Netflix cough*).

If you invest, that's on you and all risks are yours to bear. I wash my hands of any losses that you might incur just because you didn't do your homework. I am not getting paid for writing this, and I make no benefits whatsoever from giving you this information.

Simply put, I ain't yer stockbroker. Go find one and argue with him about what I'm going to tell you.

Got that?

Great. Let's proceed.

The best way to explain the right way to invest is through a picture.


That graph shows what would happen to $1, invested in 1950, adjusted for inflation, all the way to 2010.

That is 60 years of investing history, and the trend is obvious and inescapable. It is upward, unambiguously, even though there were many dips and troughs and several severe recessions during that entire period.

This tells you the entire story. If you invest money that you can afford to lose, over a time horizon of several decades, then you are harnessing perhaps the single most useful and powerful idea that ever dawned upon the human mind:

Compound interest.

Even this, however, is not the full picture.

You see, high-quality companies that produce good profits and are well managed, generally pay dividends - that is to say, they redistribute the profits that they make back to shareholders. As a shareholder in a company, you are an owner of that company - you own a claim on a tiny piece of its assets.

If you invest in a broad-based basket of stocks, like, say, an index fund or a mutual fund that tracks the performance of the S&P 500, then you get dividend payments every quarter or so. That is cold, hard cash in the bank for you - and you didn't have to do one damned thing to earn it. All you had to do was turn over your money to a huge number of faceless peons and managers, who then took that capital and used it to grow their companies - instead of doing what Netflix and Uber and all of these other high-flying tech companies are doing, and wasting it on SJW-centric bullshit.

But, what if you reinvested those dividends right back into the stock market?

Your results would look like this:


I know that this chart is a bit difficult to understand. The axis is in logarithmic scale, so every major tick-mark is an increase by a factor of 10. It shows the value of the S&P 500 over time, adjusted for inflation, and with dividends fully reinvested.

That result shows an even more unambiguously positive outcome. If you invest your money in one big lump sum in the stock market for anywhere from 10 to 40 years, reinvesting dividends the whole way, you are guaranteed to see it grow, in real terms, throughout that time period. It is simply not possible for you to lose money, based on the historical performance data that we have available, going all the way back to 1870.

But even this, as amazing as it sounds, is not the best possible investing strategy, because you just plonk one big pile of money in the market and hope for the best.

The absolute best investing strategy, the one that guarantees low-risk returns over a long time horizon, is dollar-cost averaging.

This simply means that you invest a fixed amount of your pay cheque every single month into a retirement vehicle, like a 401(k) or an Individual Retirement Account, or your particular country's tax-advantaged equivalent of the same.

This provides an automatic stabiliser in your investments. Because you are investing a specific fixed amount every month, when the market is going gangbusters and setting new highs every other day, then your dollars purchase fewer and fewer shares because prices keep going up.

But, by that same token, when the inevitable corrections come and prices collapse again, your dollars buy more and more shares, because now prices have cratered and your every dollar gets way more mileage.

The result is an automatic stabilisation process that sees you through the highest highs and the lowest lows, and quietly, relentlessly, inevitably builds up your capital - while still giving you a big tax benefit, because you don't pay taxes until you retire on the money that you have invested.

In other words - if you invest that money in the market, you get to knock that off your tax bill and possibly get a portion of your money back from the never-to-be-sufficiently-damned IRS.

Now what do you suppose will happen?

Take a look at this website and play around with the inputs for a bit. It's not that hard to figure out, actually - comes down to a relatively simple mathematical formula, really.

The long-term inflation-adjusted return of the S&P 500, as computed by Jeremy Siegel in his classic investing textbook, Stocks for the Long Run, comes to roughly 6.4% or so. If you start with an initial investment of $1,000, and invest $100 every month, with a 6.4% projected real return, for 40 years, and withdraw a maximum of 5% of your final account value every month for as long as that money lasts...

You end up with a final account balance of $234,988.73.

Assuming that, once you begin drawing down your money at 5% per month for as long as it lasts, the rate of return on whatever is left will be about 2% - very roughly the historical yield on long-term US Treasury bonds - then your money will last you just shy of 26 years, and you'll be able to withdraw $979.11 every month.

I'll grant you, those numbers don't sound terribly impressive - until you realise that your total investment was only $49,000.

For just shy of $50K, invested over 40 years, you're getting damned near 5 times that amount back.

And, as I pointed out above, if you are reinvesting your dividends in a broad-based portfolio of stocks, then you cannot lose over a 40-year time horizon. The historical data are absolutely unequivocal about this.

That is the exact opposite of a casino. That is a long-term money-printing machine.

And it's all perfectly legal for you to use and access and take advantage of.

So let's say you're intrigued by what you've learned here. Surely, you think to yourself, there must be ways to juice your returns a bit more by picking individual stocks?

Yes, you can. It isn't even particularly difficult. You just have to learn how to analyse a company, and that requires mastering a few simple mathematical and accounting concepts, and having the patience to pore over corporate financial statements.

These barriers alone are enough to turn most people away.

The reality is that this kind of investing is staid, boring, and hard work. It's not difficult work, it's just tedious.

But, if you put in the work, you can get to the point where you can figure out how to invest in companies where you could buy the entire operation for less than the actual cold hard cash that it has in the bank.

How is such a thing possible, you might ask?

Well, that's a post for another time. It's a big topic and I am not even remotely an expert on it. For that, you would have to turn to books and articles by legendary investors like Warren Buffett, Tim Staermose, and the Dean of Wall Street, Benjamin Graham.

If anyone is really interested in such stuff, let me know in the comments. But for now, I will leave you with one simple thought:

As long as you aren't dumb enough to gamble with your money, but instead decide to invest it using simple, proven, time-tested principles of thrift and discipline, then the stock market is your own personal perpetual money-printing machine.

Comments

  1. I'd like a practical if you have time to put one together. I.e,, here's where to find good info, here's how to read the info, and so on. I can do the math no problem, it's where to get info that I'm out of my depth.
    Also, I'm expecting a lot of trouble in the upcoming decades, being in the US. How would you change your investment behavior if you had less than 20 years to capitalize on the US stock market?
    The data you use suggests the minimum time for investment is 10 years. Assuming an investment for that period, would you still use dollar-cost averaging?

    ReplyDelete
  2. I'd like a practical if you have time to put one together. I.e,, here's where to find good info, here's how to read the info, and so on.

    Yeah, could do. Might take a while, but it's a distinct possibility.

    Also, I'm expecting a lot of trouble in the upcoming decades, being in the US. How would you change your investment behavior if you had less than 20 years to capitalize on the US stock market?

    Change my allocation away from US-based securities and markets, for one thing. The major reason why the US is the world's premier destination for capital is because of its transparency and strict regulations concerning corporate financial disclosures. Various countries and regions all have their own laws concerning corporate disclosures; the US is generally agreed to be the most transparent and easy to understand. This makes picking individual securities in the US much easier than in, say, southeast Asia or the Middle East or especially Eastern Europe.

    That said - it is possible to invest in index funds that simply track a big basket of stocks from different parts of the world. That is my recommended course of action, if you're willing to accept higher volatility in the returns as a result.

    Note also that this implies investing in foreign bonds, not US Treasuries. I believe that US Treasuries will face a massive crisis of confidence within 20 years, due to all of the impossible promises made to various parts of the US population. The USA will default, one way or another. This means that alternative high-quality bond offerings have to be looked at very carefully for stability and yield, but these are hard to find in international bond markets.

    The data you use suggests the minimum time for investment is 10 years. Assuming an investment for that period, would you still use dollar-cost averaging?

    I would recommend DCA for any time horizon greater than 5 years. Anything less than 5 years requires a speculator's mindset, not an investor's. DCA is simply the best way available to smooth out one's returns and stabilise a portfolio in the face of significant market volatility.

    ReplyDelete
  3. The only reason it goes up like that is because it's a ponzi scheme. Without the millions of investors forced into the market by the invention of the 401k and the destruction of pensions it would never have jumped up that high.
    It's a casino even if you personally aren't gambling. If 90% of the people around you are gambling you are in a casino. It doesn't matter if you are only there for the free buffet.
    It's not guaranteed money. When the stock market crashed in 08' it did so because of the bad actions of a few and it effected everyone. If you are drawing out money at that time the effect will be permanent.
    they never actually fixed anything that was wrong from the 08 crash. That means we are guaranteed another one. This one will probably be bigger. I doubt nations much less markets will survive.

    ReplyDelete
  4. Post Alley Crackpot17 May 2019 at 07:18

    There's a Mister and Missus Watanabe on line 1 ...

    They say they like this idea of a "money printing machine" of yours, so they want you to stick all of their money in ETFs because they were told to by Suze Orman.

    Honest Abe's been sticking it to them despite gains in the carry trade, so they're hoping you can help them print their way back to prosperity again.

    Some joker really should create Casino Industry ETFs, BTW. :-)

    ReplyDelete
    Replies
    1. They say they like this idea of a "money printing machine" of yours, so they want you to stick all of their money in ETFs because they were told to by Suze Orman.

      I never said that you should put ALL of your money into the stock market. That is a downright stupid thing to do.

      Just about every investor who knows his trade has always said that a reasonably diversified asset mix is key to reducing volatility and enhancing returns.

      That means a good solid mix of hard cash, stocks, bonds, some real estate, precious metals, and a very small number of speculative investments. For a young man in his mid-20s to mid-30s, that would look something like:

      20% cash, 50% stocks, 20% bonds, 5% real estate, 5% speculative.

      As you get older and closer to retirement, the stock percentage should go down and the cash and bonds percentages should go up.

      Some joker really should create Casino Industry ETFs, BTW. :-)

      Seek, and thou shalt find...

      Delete

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