Yesterday, I was driving a friend home when he mentioned a conversation he had with a friend of his. My friend’s friend apparently has a horrible impression of the stock market and likened it to a big, rigged casino. My response to that? Yes it is – but only if you want it to be. The casino wannabe In 1995, The Motley Fool’s co-founder, Tom Gardner, was in a bar in the U.S. when he met a man who was clearly a big fan of motorcycles – he was clad in full biker-gear. The biker guy started chatting to…
Yesterday, I was driving a friend home when he mentioned a conversation he had with a friend of his.
My friend’s friend apparently has a horrible impression of the stock market and likened it to a big, rigged casino. My response to that? Yes it is – but only if you want it to be.
The casino wannabe
In 1995, The Motley Fool’s co-founder, Tom Gardner, was in a bar in the U.S. when he met a man who was clearly a big fan of motorcycles – he was clad in full biker-gear. The biker guy started chatting to Tom and introduced himself as a “Harley Guy,” referring to the iconic U.S.-based motorcycle maker, Harley-Davidson Inc.
Upon learning that Tom’s job deals with the stock market, the biker guy shared his own investing experience.
Turns out, he had lost a lot of money in the stock market years earlier, ‘investing’ in a company he did not understand at all after following ‘advice’ from a stock broker. This episode gave the biker guy a jaundiced view of the stock market, so much so that he likened it to a big gambling machine.
Tom then asked: Have you considered investing in Harley? The biker guy was surprised – he never knew Harley, a company he was so intimately familiar with and understood well, was something he could invest in.
I can’t know for sure if our biker guy ever invested in Harley, but if he did, he’d very likely be a happy man today and have a completely different perspective on the stock market.
Harley had earned US$113 million in profit in 1995 and was trading at US$5.31 (adjusted for dividends) at the start of that year. Today, with Harley’s profit having grown to US$785 million, the beloved motorcycle outfit’s shares are exchanging hands at nearly US$49 apiece.
What this little story shows is that the stock market is like a casino only if we go in blind without understanding what we’re investing in. As investors, we have the freedom to choose any stock to invest in.
If we’re invested in a company’s stock yet have no idea (1) how the firm makes money, (2) what its business does, (3) how its business is doing, (4) how the business will likely fare years in the future, and (5) the caliber of the managers running the show, then we are gambling with our hard-earned capital.
But, if we have a good handle on those various aspects and find the stock to be trading at a reasonable or attractive valuation, then I’d humbly summit that we are investing.
The rigged game
In casinos, the odds are always in the house’s favour and there’s nothing much we can do to change that. In investing though, individual investors like you and me have the ability to tilt the odds of success in our favour. How? Through something simple: Time.
Professional investors have an edge over individual investors in many areas. Resources. Connections. Research. Capital. There can be more. But, they lack one of the biggest edges: Time. You see, the longer we can stay invested in stocks, the lower our odds of losing money.
Unfortunately for the pros, they don’t have this luxury. In 1997, Jim Cramer, an ex-hedge fund manager who’s now a financial TV pundit, said the following in a TV interview:
“My investors, they’d take it away from me if I take a six-year period – they’d think that’s a dodge. I gotta perform. Maybe I’m a dancing bear, but I don’t mind it.
It’s the way good money management’s practiced. I’m supposed to bear the averages regularly. Beat them every day if I can; beat them every hour if I can. I’d love to take a six-year perspective, but the people whose money I’m running, they ain’t taking that so I can’t.”
The benefits of having time on our side are immense. Here’s a chart from my colleague Morgan Housel. It shows the returns of the S&P 500 – an important U.S. stock market barometer – from 1871 to 2012 for different holding periods ranging from 1 day to 30 years.
What is obvious is how the historical odds of making losses fade rapidly with time. Hold stocks for months, and you’re at the mercy of the market’s vicissitudes; hold them for 20 years or more and stocks in the U.S. have never made losses.
This is a phenomenon that’s replicated as well in Singapore’s stock market. If returns for the Straits Times Index (SGX: ^STI) are measured at the start of every month from 1988 to August 2013, the index has clocked a loss 41% of the time for a one-year holding period. Stretch the time horizon to 10 and 20 years, and your chance of sitting on a loss dwindles to 19% and zero, respectively.
The theme is clear: Our odds of success rise along with the time we stay invested for. By adopting a short time horizon, the stock market will be akin to a casino, with our investing-fate to be decided by the flip of a coin. If we are patient and adopt a long time horizon, the story changes.
A Fool’s take
The stock market can be a dangerous money-vacuum that works like a big, rigged casino. But that’s true only if we allow it to be. If we have the right investing behaviour, the stock market could become a very different place, a place where we can compound our wealth slowly but surely.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.