Mr. Moneyaire and I both enjoy playing roulette. However, we have very different styles. Mr. Moneyaire finds the way I play roulette to be a bit annoying. I find the way he plays to be reckless. However, the way we play roulette can teach us important investing concepts.
I like playing roulette. There’s a wheel with 37 or 38 numbers on it in either red, black or green. The dealer will spin the wheel with a ball tumbling around the wheel. Where that ball lands determines what number and color, wins. It’s a fun game and I like it because it’s random.
The way we play
I’ll usually have $100 with me when I sit down to play. I’ll basically make bets across the board. I do lose, but more often than not, I win. I don’t win much. I think the most I’ve walked away with is an extra $40. I can however, stay in the game for a long time, with my initial $100. In fact most of the time I give some chips to Mr. Moneyaire so he can keep playing. He loses more often than I do.
Mr. Moneyaire plays very different than me. He plays a small set of specific numbers. He loses often, but when he hits, he hits big. One year in Vegas he won over $2,000 at the roulette table. I fear, though, that he’s lost more than that in the years preceding that single win.
Investing is gambling when you do it wrong
A lot of people will say that investing in the stock market is a lot like gambling. That’s very true for a certain kind of investor. If you’re picking hot stocks (or funds) you don’t know much about, going all in on them, buying and selling frequently, buying on emotion – then yes, you’re probably more gambler than investor.
In gambling there’s a popular phrase, “The house always wins.” Casinos know a majority of folks who are gambling are doing so on emotion and little skill. Plus, casinos stack the odds in their favor ever so slightly. Casinos hedge their bets; $5 black coffees, ridiculous resort fees and over priced everything. They are some of the shrewdest investors ever.
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What roulette teaches us
Well, first skip picking stocks. Like Mr. Moneyaire’s number picking strategy, chances are you won’t pick the right ones. The panic that sets in to your gut and chest when you see your portfolio down 10%, then 15% then 20%… that fear and pain is real. The reaction to sell to stop the pain and the losses is real. You might even stop investing for the most part.
This line of logic extends to actively managed funds, especially those with high fees. If you think fund managers are immune to the emotions and behaviors most of the rest of us act on when stocks trade down or up or when they’re being talked up or trashed, you’re fooling yourself.
Stock picking gurus
Even well pedigreed, famous money managers won’t pick the right companies to bet, err invest, in. Just look at Cathie Wood and her Ark Funds. She was a celebrated stock picking guru in 2020. Bloomberg named her best stock picker in 2020. Her fund was super hot and going up up and away in 2020 and 2021. Then, it lost hundreds of millions in value. By the end of 2021 Morningstar named her fund one of the 10 biggest wealth destroyers. Her fund has lost about $1.3 billion to date. Ouch.
In fact, most actively managed funds fail to beat the market. What they won’t fail at, however, is charging you for the opportunity to play. Besides avoiding stock picking/ers stay away from funds that charge fees north of .20%.
This is probably one of the more important investing concepts. Numbers, colors, odds or evens always have the same probability for showing up. Numbers don’t get hot and they don’t owe you an appearance. Don’t become emotional when investing. Don’t buy a stock (or currency for that matter) because it keeps going up and everyone is jumping on the bandwagon and you’re getting a serious case of FOMO. Don’t buy into a sophisticated, complicated, opaque investment that doesn’t make sense to you. Don’t invest in meme stocks. Before buying stock in a beaten down company, make sure it’s not a Kodak-esque situation.
Take the emotion out of it and give it time. Do your due diligence. Stay away from anyone urging you to put money in now now now!
During bear markets or recessions stocks start losing value for no fault of their own. Or perhaps they had a bad quarter or two, but the outlook is still good for them and the industry. Regardless, a lot of people will sell, so they don’t lose more. They sell out of good stocks and funds because they get scared. They’ll also be kicking themselves in a few months when the price starts going back up and they end up buying back in at a higher price than when they sold.
A case of the heebie-jeebies
Let’s use celebrity (at least in finance circles) activist investor Bill Ackman as an example. Netflix was hit hard when it posted declines in memberships. It went from a high of $508 in January of 2022 to a low of $162.70 by June of 2022. Bill bought up about a billion dollars worth of stock in January 2022 but then got cold feet. He sold his shares for a $400 million dollar loss by April of the same year. In January of 2023, Netflix stock is back up around $320 a share. The well pedigreed, smart, savvy, sophisticated, intelligent, experienced financial guru got a case of the heebie-jeebies. Not clear yet if Bill made the right move, but I have a feeling he might be kicking himself a little.
That’s actually how you end up losing more. It reminds me of when gamblers play “their” numbers. When they start losing they switch numbers only to lose even more when “their” numbers start hitting again, so they switch back. Though, Bill hasn’t bought back in as of the time of this writing.
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Do this instead
Diversification is just a fancy way of spreading your bets. But, how does one diversify?
A co-worker encouraged me to invest in my 401k when I first was starting out. I asked, “What I should invest in?” They said diversification was important. Okay… how do I do that? They told me to do what they did; pick several funds available in the 401k list until 100% was hit. The logic; by investing in several different funds you’re diversifying investments. Seemed legit, and I followed that advice in the beginning. But that’s not diversification.
Diversification is important. It means investing in all parts of the stock market and even into bonds. Maybe into real estate, too. Instead of stock picking or going with actively managed funds, invest most of your money into broad low cost index funds. Doing this will help you diversify. Two funds I really like and invest in are IVV and VTI.
Passive. Broad. Index.
IVV and VTI are passively managed Exchange Traded Funds (ETFs). Buying into either one will provide a good amount of diversification. No need to buy both, either is a good one. Plus, if you’re using a discount brokerage like Fidelity or Schwab, they offer access to similar funds at NO COST!! Check out FZROX on Fidelity or SCHB on Schwab. Both are nearly identical to VTI or IVV, except they’re fee free.
A bit more on IVV and VTI
IVV is made up of the top 500 companies in the S&P 500. Buying a single share of this fund is like getting a tiny piece of the pie at 500 large established companies. Buying into VTI is like buying into every single company in the US stock market, that’s over 3,000 publicly traded companies. These funds are basically indexing – or trying to replicate either the S&P 500 or the overall market’s results. Its an excellent way to diversify between industries, sectors, company size and even geographically. The fees for either fund is .03%. There are no load fees, no minimums and shares of these ETFs trade like stock.
Just like the waiters coming by to offer free drinks while you gamble, these index funds will give you a little something to keep you interested in staying invested in the form of a dividend. VTI has an annual yield of about 1.59% or about $3.18 per share and IVV’s annual yield is 1.66% or about $6.39 a share.
When you invest in either of these two funds you’re doing the opposite of picking stocks. You’re playing the whole market. When you invest in these funds you’re betting that the US stock market will go up in value over time. It’s like betting that the house will win. I can’t guarantee you won’t lose money, especially in the short term. You probably will. But overtime the US stock market has gone up in value. If you stay long, your chances of coming out ahead are good.
Singapore Sling meet the Bond Sling
Also, remember those $5 coffees I mentioned? Casinos sell those to hedge against losses they might face in gambling operations or what not. You can do the same thing by buying bonds. I bonds are currently offering a 6.89% interest rate. Its one of the easiest ways to get into bonds. There are also bond funds like Vanguard’s emerging markets bond fund VWOB that provides a rich dividend and diversification of bond exposure internationally. As of this writing, the fund’s yield is about 5.26% and has a fee of .20%.
Time is on your side
Another important investing concept roulette teaches us is that the longer you can play, the better your odds of walking away a winner. Mr. Moneyaire usually has to pull me away from a roulette table after an hour or two to eat or do something else. I typically walk away with an extra $8. Which, with an initial $100, isn’t a bad return. (I can feel Mr. Moneyaire’s eye roll, ha!)
In the short term stocks, and even bonds, can be very volatile. You can be down a lot or up a lot at any given time. Investing can make you feel like an idiot or like a wise wizard. Be patient with your well picked, low cost educated investments. Remember the important investing concepts in this article and you’ll more likely make it out an investing winner than a loser.
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Place your bets…
Wisely. Give them time. Be patient. Understand the game. Be in control. And heck, if you can’t beat ’em, join ’em!