Are we through the looking glass?

[soupcxan]

Imagine yourself 5 or 10 years ago. If someone had told you then that their investment in a plain-jane money market account would outperform your portfolio of any reasonable combination of equities (small cap, large, value, growth, international, REITs, etc.), would you have believed them? I would have estimated the odds of that to be <1% and told them to take off their tinfoil hat.

Yet we find ourselves in that situation today. Not to mention some other extraordinary events:

• Mortgage contracts are being unilaterally written down by judges.
• Bonuses are being retroactively confiscated by the government with no due process.
• The Fed's balance sheet will soon exceed $300,000,000,000.00.
• Effective nationalization of large companies in critical industries (banks, automakers)

All the rules seem to be changing daily. No matter how safe I try to make my investments today, it seems I am placing a bet on how things will turn out. Even things like Treasuries, cash, or TIPS could be terrible investments over the next 10 years, depending on which scenario comes to pass. So I can't opt out. But my ability to predict the next 10 years isn't any better than it was 10 years ago. So how am I supposed to make prudent decisions for my future welfare?

Maybe I'm being too post-modern about all this, but "before" when you invested, you could identify the biggest risks (the "known unknowns") and either accept them, or pick a different investment. Now, it seems that the biggest risks you face are impossible to classify or quantify (the "unknown unknowns").

 

[Grep]

Depending on your circumstances, it may be time to take the "unsafe" bets.

Remember, the one statement in life that is always true is "this too shall pass."

 

[haha]

All the rules seem to be changing daily. No matter how safe I try to make my investments today, it seems I am placing a bet on how things will turn out. Even things like Treasuries, cash, or TIPS could be terrible investments over the next 10 years, depending on which scenario comes to pass. So I can't opt out. But my ability to predict the next 10 years isn't any better than it was 10 years ago. So how am I supposed to make prudent decisions for my future welfare?

Very well put. One can't really. We just do our best. IMO one of the best is a well diversified portfolio strongly tilted toward quality, high ROA companies with growing dividend streams.

Not perfect, there are many possible criticisms, but not bad either. Best would be to be a politician and divert some of these masive flows into your own coffers.

Ha

 

[ziggy29]

I'm mostly betting on reversion to the mean... but I am hedging my bets somewhat. This is no garden-variety economic slowdown, and while I'm not in "doom and gloom" mode expecting all out financial apocalypse, I am hedging about 20% of my portfolio with stuff that could hold value should the economy go deeper into the toilet and the dollar becomes toast.

But for the most part, I'm still dancing with the one that brought me here. Though my equity exposure is more tilted toward more stable, higher-dividend blue chips.

 

[Dawg52]

Depending on your circumstances, it may be time to take the "unsafe" bets.

Yup, "bets" pretty much sums up the stock market. Legalized gambling.

 

[FUEGO]

I view equity investing as if I am buying a lottery ticket with an expected payout greater than 1. You never know what you will get, but if you hold on to it for a couple decades, you think there is a good shot of hitting the jackpot. Higher return and high standard deviation.

If I bought the money market lottery ticket, I know I am getting a return equal to inflation, plus maybe a percent.

Ex post, clearly the money market lottery ticket was a better bet. Ex ante, circa 1999, could you have said that a 100% allocation to money markets was the best bet?

I would suggest that a properly diversified portfolio invested in low cost, low turnover mutual funds that provide broad exposure to asset classes with low correlation is the best investment strategy going forward. Of course, temper your equity portion with bonds to match your risk tolerance and bake for 10 years. Serve when steaming hot in the middle.

I just took a quick peak at the 10 year returns on a number of funds offered by vanguard. The best performing money market fund was actually 33rd or so on that list. Outperforming it were a few funds that frequently are mentioned here, to wit, Wellington, Wellesley, a number of bond funds, Emerging Markets, Precious Metals and Mining, and Energy.

And many of the preferred slice n dicer asset classes do not lag far behind the money market returns: Small Cap value, REIT, international value, small cap.

So, yes, the equity lottery ticket was a loser vs. the money market lottery ticket, but not by a long shot. And I'm starting the measuring period in 1999, a period filled with manic positive outlooks on the economy riding the longest wave of economic expansion we have seen in modern history. And I'm ending this period today, in the middle of the worst market correction since the great depression. And yet the equities lottery ticket still did okay versus the money market.

I'm playing this game again.

 

[freebird5825]

Past performance is no indicator of future returns.
Not FDIC insured.

I think I remembered those correctly. There it is in black and white.
No guarantees folks.
Put your money up and spin the wheel.
Only bring what you are willing to lose.
The good news is...yes...this too shall pass.

 

[Notmuchlonger]

Past performance is no indicator of future returns.
Not FDIC insured.

I think I remembered those correctly. There it is in black and white.
No guarantees folks.
Put your money up and spin the wheel.
Only bring what you are willing to lose.
The good news is...yes...this too shall pass.

Round en round it goes where it stops noooobody knowsss

 

[LOL!]

The fact that you started this thread suggests that you are alive and well even after one of the worst 10 years in the market. What that suggests to me is that we could have another worst 10 years and we would all be alive and well even then.

So I'm not gonna worry about it because worry didn't help the last 10 years and won't help the next 10 years.

And you can tell your kids what it was like to live through the Great Recession. I doubt though that you will be like my mother-in-law who would eat out of our garbage can whenever she came to visit. It was a habit she picked up in the Depression.

 

[Shawn]

I view equity investing as if I am buying a lottery ticket with an expected payout greater than 1. You never know what you will get, but if you hold on to it for a couple decades, you think there is a good shot of hitting the jackpot. Higher return and high standard deviation.

I look at it in a similar way and I'm not a betting man.

It's essentially a coin-flip (50-50 chance) on whether my equity portfolio will rise or fall on a given day. And it usually moves by non-trivial amounts (> $1000). In effect, each day I bet $1000 (or more) that fate will be on my side. About half the time I win. About half the time I lose.

Likewise, a red (or black) bet at the roulette wheel in Las Vegas also has odds of about 50%. I could bet $1000 each day on a single roll of the wheel. About half the time I win. About half the time I lose.

These are similar scenarios with very similar odds. Yet one is an investment and the other is gambling. It all depends on which side of 50% the odds fall. In the short-term, I can't tell the difference. In the long-term, I can.

No. Investments aren't like gambling with well computed odds. There are reasons investments tend to increase (e.g., long-term economic growth). Still, I've always been fascinated with the investment-gambling analogy. Despite their very similar odds, one is prudent and the other is fiscally irresponsible.

 

[Dawg52]

.

No. Investments aren't like gambling with well computed odds. There are reasons investments tend to increase (e.g., long-term economic growth). Still, I've always been fascinated with the investment-gambling analogy. Despite their very similar odds, one is prudent and the other is fiscally irresponsible.

I agree. The last 10 years have been fiscally irresponsible. And I didn't go to any casinos.

 

[DblDoc]

Now, it seems that the biggest risks you face are impossible to classify or quantify (the "unknown unknowns").

Those were always there whether you were aware of them or not. They were there 10 years ago and are there today. A well diversified portfolio still remains the most likely to succeed.

DD

 

[Bikerdude]

And you can tell your kids what it was like to live through the Great Recession. I doubt though that you will be like my mother-in-law who would eat out of our garbage can whenever she came to visit. It was a habit she picked up in the Depression.

Maybe she didn't like what you were having for dinner.

 

[Grep]

All this talk about the stock market being mere "gambling" is ridiculous. Yes, there is risk, and that risk can feel like a gamble. But stock ownership is the ownership of companies that have real value and produce real products (except A.I.G., of course). Invest in a Total Stock market fund, and you own a slice of the productivity of the United States (or the world). That may sputter at times, but it is a far cry from plunking money down at a roulette wheel.

 

[pedorrero]

Grep, in addition to being a Unix utility program makes a good point, which I shall amplify: You can invest the money in good faith, but the company may do all kinds of untoward things; steal it, pay executives outrageous salaries, make dumb strategic decisions, or just be the victim of a bad economy. Add government meddling and who knows....? It is a crap shoot seems so sometimes ...

 

[Grep]

If you own the entire country or the entire world, e.g. via broad-based mutual funds, then you will be on the winning (or losing) end of population growth and increased productivity and consumption, etc. The game may feel rigged at times like these, but in the long term, "gambling" on the survival, energy, labor, innovation and ultimately the success of the one world we have is the only game in town.

Five years from now, when we are probing new highs every other day (we can hope, anyway), few will be complaining in despair that the stock market is nothing more than gambling. The few that would dare say such words would probably be scolded and told (with studies at hand) that the stock market is "actually safer than treasuries in the long run due to enhanced portfolio longevity," etc.

By the way, I'm more of a contrarian than a cheer-leader.

 

[Dawg52]

Five years from now, when we are probing new highs every other day (we can hope, anyway), few will be complaining in despair that the stock market is nothing more than gambling. The few that would dare say such words would probably be scolded and told (with studies at hand) that the stock market is "actually safer than treasuries in the long run due to enhanced portfolio longevity," etc.

I hope you are right. Then I can unload my gambling investments.

 

[ziggy29]

Five years from now, when we are probing new highs every other day (we can hope, anyway), few will be complaining in despair that the stock market is nothing more than gambling. The few that would dare say such words would probably be scolded and told (with studies at hand) that the stock market is "actually safer than treasuries in the long run due to enhanced portfolio longevity," etc.

Like the "few" who were scolded 18 months ago? Not to mention some of us thinking the same things but not having the guts to get out?

Seriously, though, if the market is hitting new highs in five years -- goodbye 70/30, hello 50/50...

 

[Gone4Good]

Maybe I'm being too post-modern about all this, but "before" when you invested, you could identify the biggest risks (the "known unknowns") and either accept them, or pick a different investment. Now, it seems that the biggest risks you face are impossible to classify or quantify (the "unknown unknowns").

Hmmmm, really?

So you mean investing in stocks was less risky before they declined 50%? Is that even possible?

The joke about investing (in all asset classes) is that the lowest future returns are garnered when investing during "safe" and "stable" times. Low risk premiums invariably lead to low returns. Now, however, risk premiums are high. That doesn't guarantee positive future returns, but it does increase the odds. Meanwhile, the risks haven't really changed . . . specific risks have just become more apparent. For example, it's hard to say that over-leveraged banks and consumers is a new risk. We're just getting paid a higher premium to accept that risk now.

 

[gryffindor]

I don't think you could have accurately identified all of the risks 15 years ago you just thought you could.

This crisis is a good reminder for all of us to really understand risk and where it lies. So the real question is where are all of the systematic risks and how do you protect yourself from them. New risks that I have been considering

Risk of human capital - ability to hold down good paying steady job (certainly high risk if you are in financial industry , lower if you are in health care)

Currency risk -- potential that dollar will dramatically lose value. Certainly when the Fed injects $ 1 trillion into the money supply in one day, the potential of this happening has gone up significantly.

Financial institution / liquidity risk -- now we all need to think about who is holding our assets and how quickly we could access them if needed.

I'm sure others can identify other new risks that they hadn't considered in the past.

 

[Shawn]

All this talk about the stock market being mere "gambling" is ridiculous. Yes, there is risk, and that risk can feel like a gamble. But stock ownership is the ownership of companies that have real value and produce real products (except A.I.G., of course). Invest in a Total Stock market fund, and you own a slice of the productivity of the United States (or the world). That may sputter at times, but it is a far cry from plunking money down at a roulette wheel.

But in the short term, the stock market is a gamble. Or better said, it's high risk (i.e., it's why short-term funds should be placed in conservative investments). On a day-to-day basis, there is little difference between the equity market and a single roll of a roulette wheel. The odds of success in both cases is about 50%. With the equity market, daily success is a little higher than 50%. With the roulette wheel, daily (one roll) success is a little lower than 50%.

This is not to say that identical forces drive investments and gambling. Gambling is driven by simple mathematics. The stock market is driven by a complex set of time dependent variables. Some are close to random. Others are systemic. And no one knows the full equation. But in terms of outcome, on a short-term basis, I can't tell the difference between a prudent equity investment and the roulette wheel. It's only in the long-term that the difference becomes clear.

All this is nothing more than saying that equity-based investment strategies need to be long-term. Although there's still risk, the likelihood of long-term success is high. It's also a way of saying that gambling is a long-term investment strategy for casinos, as long as they keep their expense ratios low.

 

[snodog]

The odds of success in both cases is about 50%. With the equity market, daily success is a little higher than 50%. With the roulette wheel, daily (one roll) success is a little lower than 50%.

But it is those few percentage points that make all the difference. Show me that roulette wheel with a success a little higher than 50% and I'll start playing that too.

 

[Shawn]

But it is those few percentage points that make all the difference. Show me that roulette wheel with a success a little higher than 50% and I'll start playing that too.

Absolutely. In terms of outcome, this is the difference between equity investing and gambling. The two are on different sides of the 50% boundary. Although short-term risks are roughly the same, long-term risks are not. Ultimately, investing wins because it is based on economic return and growth. Over the long-term, return and growth are almost guaranteed to be greater than short-term volatility and economic fluctuation. It's reversion to an upward-trending mean.

 

[Koolau]

But it is those few percentage points that make all the difference. Show me that roulette wheel with a success a little higher than 50% and I'll start playing that too.

Actually, snodog, you simply need to buy the casino. Then the odds are suddenly in your favor. That's the theory of purchasing equities. You now own pieces of companies who, to some extent, get to control the odds. Of course, there are good casino managers and bad. So just 'cause the odds are in our favor doesn't insure that we always win.

 

[NW-Bound]

One of my brothers in law has said that investing is gambling. I have tried in vain to use exactly Shawn's argument, that he should look at investing as being the house, that the odds are for you in the long run. But it does not mean you should put it "all on red". Yes, doing so may mean he could win really big, but he could also lose it all. Diversify, diversify, I told him...

He simply did not get some simple concepts of probability, so I have stopped talking about investing with him. There is no point.

About staying in the market through bad times hoping to recover, some times ago I read an article on the Web. I forgot the exact point of the article, but the author used a phrase that stuck with me. He described the "triumph of the optimists", how they have won more often than lose. Is it really different this time? I have chosen an AA that I am comfortable with, and am willing to sit this out.