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Stock Market: Shrewd Bet or Stupid Gamble?

February 10, 2014
Investing Caffeine

Investing Caffeine

1 followers
Trillions of dollars have been lost and gained over the last five years. The extreme volatility strangled investment portfolios, and as a result millions of investors capitulated by throwing in the towel and locking in losses. Melted 401ks, shrunken IRAs, and beat-up retirement accounts bruised the overarching psyche of Americans to the point they questioned whether the stock market is a shrewd bet or stupid gamble?

The warmth and safety of bonds provided some temporary relief in subsequent years, but the explosive rebound in stock prices to new record highs in 2013 coupled with the worst year in a decade for bonds still have many on the sidelines asking whether they should get back in?

As I’ve written many times in the past (see Timing Treadmill), timing the market is a fruitless effort. Elementary statistics, including the “Law of Large Numbers” will demonstrate that blind squirrels can and will beat the market on occasion, but very few can consistently beat the stock market indices for sustained periods (see Dart-Throwing Chimps).

However, there have been some gun-slinging hedge fund managers who have accumulated some impressive track records. Because of insanely high management fees, many overpaid hedge fund managers will swing for the fences by using a combination of excessive leverage and/or concentration. If the hedge funds connect with lucky returns, the managers can take the money and run. If they swing and miss…no problem. Close shop, hang out a shingle across the street, change the hedge fund’s name, and try again. Of course there are those successful hedge fund managers who have learned how to manipulate the system and exploit information to their advantage, but many of those managers like Raj Rajaratnam and Steven Cohen (Trades, Portfolio) are either behind bars or dealing with the Feds (see fantastic Frontline piece on Cohen).

But not everyone cheats. There actually are a minority of managers who consistently beat the market by taking a long-term approach like Warren Buffett (Trades, Portfolio). Long-term outperforming managers are like lifetime .300 hitters in Major League Baseball – the outperformers exist, but they are rare. In 2007, AssociatedContent.com did a study that showed there were only 12 active career .300 hitters in Major League Baseball.

Another legend in the investment industry is John Bogle, the founder of the Vanguard Group, a firm primarily focused on passive, index-based investment strategies. Although it is counter-intuitive to most, just matching the market (or index) will put you in the top-quartile over the long-run (see Darts, Monkeys & Pros). There’s a reason Vanguard manages more than $2,000,000,000,000+ (yes…trillion) of investors’ money. Even at this gargantuan size, Vanguard remains a fraction of the overall industry. Regardless, the gospel of low-cost, tax-efficient, long-term horizons is slowly leaking out to the masses (Disclosure:Sidoxia is a devoted user of Vanguard and other providers’ low-cost Exchange Traded Funds [ETFs]).

Rolling the Dice?

Unlike Las Vegas, where the odds are stacked against you, in the stock market the odds are stacked in your favor if you stay in the game long enough and don’t chase performance. Dr. Ed Yardeni has a great chart (below) summarizing stock market returns over the last 85 years, and what the data highlights is that the market is up (or flat) 69% of the time (59/86 years). The probabilities are so favorable that if I got comparable odds in Vegas, I’d probably live there!

Source: Dr. Ed's Blog

Source: Dr. Ed’s Blog

Unfortunately, rather than using this time arbitrage in conjunction with the incredible power of compounding (see A Penny Saved is Billions Earned), many individuals look at the stock market like a casino – similarly to betting on black or red at a roulette wheel. Speculating about the direction of the market can be fun, and I’ve been known to guess on occasion, but it’s a complete waste of time. Creating a long-term plan of reaching or maintaining your retirement goals through a diversified portfolio is the way to go – not bobbing in out of the market with cash and bonds.

At Sidoxia, we don’t actively trade and time individual stocks either. For the majority of our client portfolios, we follow a growth philosophy similar to the late T. Rowe Price:

“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”


Nobody knows the direction of the stocks with certainty, and irrespective of whether the market goes down this year or not, history has proven the stock market has been a shrewd, long-term bet.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.


Rating: 4.8/5 (4 votes)

Comments

AlbertaSunwapta
AlbertaSunwapta - 5 months ago

I don't think life is that simple.

For instance: You say "stock market". I presume you are ok with moving between stock markets. The Japanese investor that began investing in the Nikkei say 15 years before it peaked likely didn't do all too well as it fell 75%-80% from it's peak. However the Japanese investor that timed the market and left it sometime shortly before 1989 - say 4 or 5 years early may have done a bit better.

Buffett once highlighted how the DOW went 17 years, from 1960s to late 1970s and ended up at the very same level. Had someone hit retirement during the 1960s with the plan that equity growth and dividends would fund retirement, may have been disappointed as the market rose and fell around that early 1960s level. Dividends and growth would have been good but not consistent and the 1970s collapse could have been very financially threatening to the retiree then needing to sell equities into the collapse. The actual real world "timing" of various retiree exits from the markets over a two decade span could have had dramatically different return, and thus lifestyle, results.

I would say Buffett too has timed the stock market, essentially leaving it at least twice. (Though the first known occassion, in the late 1960s, he kept personal positions, he is still basically described as having "left the market" and returned all investor money to them.)

olympiamr
Olympiamr premium member - 5 months ago

I agree with the comment above. Buffett may not be a market timer in the conventional sense. He buys when there is pessimism in the market. Isn't that technically market timing?

softdude2000
Softdude2000 - 5 months ago

Buffett dont time the market. He dont look for 52-week lows. When he bought KO or IBM, they were not selling at 52-week lows.

SeaBud
SeaBud premium member - 5 months ago

Buffett clearly prefers a holding period of "forever". However, he is a value investor. He buys when he sees value and, in fewer cases, sells when values are absurd. This is not based on timing. For example, I would bet that if Wells Fargo went to a P/E ratio of 50, Buffett would sell. Further, it would not matter whether Buffett had owned WFC for 1 year or 30 years, he bought it with a margin of safety and if it became absurdly priced, he would sell. Not timing.

I think the Japanese market and the 17 years in the US market of flat returns illustrates two things. One, it illustrates the down side of indexes, not the downside of staying invested. There were stocks in those markets that rose during that time. However, if you bought the index at its peak, you would suffer the over valued stocks. Second, Buffet does buy internationally... when he sees value (ie, Tesco). Again, however, a pure value issue and not a timing issue. Sitting on cash when there are no values available is NOT timing, it is value investing.

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