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Investment should not be 'luck'

7 Jun 2021 3 month(s) ago

 

Investing in shares should be nothing like gambling at a casino.

One of the myths in stock market investment is that it is like gambling. It is not. In gambling, the house always wins. In the stock market, investors mostly win. True, if, as many small investors do, they buy when prices are high and sell when prices are low – the long noted irrationality of market behaviour – they can do very poorly. But if they do nothing when there is a sharp downturn and resist the fear-of-missing-out on the way up, then they can usually capture the average market return, which is generally a reasonable outcome. That is very different to gambling, where only the very fortunate do well.

What we do know is that approaching investment like a gambler – trying to beat the “house” – does not usually work. Carl Richards calls it the “behavior gap”: the tendency to move in and out of markets at just the wrong time on the incorrect assumption that investment is a gamble. In fact, the best outcome is often not to make a bet at all.

Creating a diversified portfolio and holding on to it for a long time is both a sound strategy and the very opposite of gambling, or relying on luck. It is in effect, saying, “I don’t want to play this game of poker, I will just sit here and take the ups and downs.”

Many conservatively inclined investors shy away from shares because they think it is like going to a casino, putting most of their money in fixed interest securities saying: “I will just leave my money in cash because I don’t trust financial institutions. I don’t trust corporations. I don’t trust corporate governance.” Although it is true that active stock picking and forecasting is a bit like placing bets at the table – and it is also true that many investors have been ripped off by Wall Street types behaving as bookies or spruikers – it is important not to rush to the other extreme.

Seeing investments as a matter of luck penalises both pessimists and optimists. The optimist goes in and out of the market, generally ending up with a much poorer return than the market average. The pessimist stays out of the market, thinking it is just for gamblers, instead choosing the no risk alternative of fixed interest. This may be low risk, but it also ensures a low return. In Australia currently, interest rates on government bonds are below inflation, so investors are actually going backwards.

The sound conclusion is to assume that the market has its ups and downs and that investing should not be a matter of picking those fluctuations. Instead, it is best to stick to a consistent strategy. You won’t be able to “beat the house”; you will be able to be the house.

Reader note: These is general reporting only and should not be considered in any way to be investment or tax advice for individuals. For more information please read our disclosure statement.

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