CW Newsletter September, 2021

CW Newsletter September, 2021

September 29, 2021

The Stock Market is Rigged – In Your Favor

You will often hear investors refer to the stock market being “rigged” as a basis for not investing in equities. They are suggesting that stocks are somehow manipulated or controlled in a way that is going to cause you to lose money. If this were the case, then those who are ‘rigging’ the market (newsflash – no one is or possibly could over time) are doing an exceedingly poor job. Often those same people are happy to head to Vegas where indeed the system is actually rigged to favor the house and put the customer at a disadvantage.

Let’s dig deeper. When it comes to blackjack, the casino has an approximately 2% edge which sounds very small but is enough for them to make huge profits (which you could also enjoy were you to make good investments in the right casino stocks – as in, be the house, not get your house taken from bad bets). For stock investing, if you want to think of the game as being rigged then you need to acknowledge, based on statistics, that it is massively rigged in your favor. Stocks go up on average about 4 out of 5 years. Over 10-year periods (a relatively short holding period for anyone with a retirement account) the win ratio for the US stock market jumps to nearly 100% when factoring in dividends while returns across these 10-year periods average around 9% annualized. Therefore, if the stock market game is rigged by some unseen hand on Wall Street intent on hurting the little guy investor, then they need to find another line of work because the net result of their so-called manipulation and dishonesty has led to one of the greatest wealth creation machines in history.

Of course, in any industry or large group of people you will always find a bad apple. But that does not mean the entire system is broken. For those who believe in such conspiracy theories to the point of choosing to keep money in cash (or potentially worse yet speculating their hard-earned retirement money on risky ventures rather than letting the power of stock market compounding work for them) they are potentially costing themselves a retirement they deserve and can attain through prudent financial planning and investing.

Remember, when it comes to vaccines, elections, or the stock market, simple emotionally compelling falsehoods are easy to espouse as the culprit for someone’s given woes. It is easy to play the victim card and say it is the other guy’s fault for your state in life, especially if the other guy is some unnamed shadowy group allegedly hiding behind a curtain and pulling strings you can’t see. But the fact is that when it comes to stock investing, all the evidence of the positive power of the markets is right in front of you. The returns prudent and patient investors can attain are right there for anyone to see. And rather than focusing on some aberrational (and often not fact based) hype about what is behind a given day’s market decline, focus instead on fundamentals like how many stores SBUX is opening daily and how popular their latest beverage offerings are. When I go into my local SBUX each morning and see drink after drink lined up for eager, happy customers, that gives me solace about this company as an investment, no matter how much alarmists ring the bell about some dark hand behind the scenes rigging the market.

Be Thankful You Have No Crystal Ball

Financial pundits are asked daily to predict the outcome of some economic event (a Fed meeting, an employment report, etc.) as well as how stock markets will move in the near term. Here’s a little secret: they have no idea on any given macroeconomic event, let alone how the markets will react to it.

To be sure, if you had a crystal ball and could know ahead of time the news headlines of tomorrow – economic, political, and otherwise (everything but stock market prices) – and make timing bets accordingly, you would likely be a whole lot poorer than you are today. History is littered with events which occurred where the market reacted in the exact opposite direction as expected – either upon the news, or shortly thereafter. Just recently you’ve had terrible headlines about employment, covid cases, and exogenous events like the potential blow up of a large financial institution in China which hit the wires with stocks dropping for a few hours, only to rebound within days. Even if you could get all the variables right consistently – what the key events are (at any given time there are dozens of major political, economic, financial, and other variables impacting near-term stock prices), what the outcomes will be, and how the stock market will react, are you really going to be able to get out and back in within a matter of days or even hours? A couple months ago the market dropped 900 points on a Monday and looked like we were headed for a crash. However, by Friday the market was up 2% on the week which included the loss on that Monday. Something very similar happened last week with the markets down nearly 1000 points at the low Monday but finished the week in the black. Is that how you want to spend your time – trying to get in and out of stocks on a daily or even hourly basis? When, as noted above, the longer you stay in the market the higher your odds of ‘winning’, why would you attempt to do the impossible of trying to predict the unpredictable and timing that which cannot be timed?

Investors try to predict near-term market movements and time them because they think it is a source of risk mitigation – as in, they want to reduce market risk by not being in the market when it goes down. Other than boredom and having nothing else to do, why would investors try to dart in and out of the market when time and trends are on their side? Bottom line, stock market predictions are not a source of risk mitigation. Having cash set aside for near-term expenses is a the ultimate form of risk mitigation. Investing money in stocks that you don’t need for two to three years or more is a source of risk mitigation. Spending less than your income is a source of risk mitigation. Being well diversified, knowing what you own, buying only the highest quality companies with strong balance sheets – these are all sources of risk mitigation. They are not sexy, they will not give you an adrenaline rush, but they will allow you to sleep well at night and increase the odds dramatically that you achieve any given financial goal, which is the whole point of prudent and disciplined investing.

The Most Elegant Solution is Sometimes the Simplest

Now that we can agree that a) the stock market is rigged in your favor and that b) market timing is a fools errand, what’s better than a simple and elegant strategy for implementation? Enter dollar cost averaging. By now, if you are investing cash, we have determined that the time horizon is greater than 2-3 years and we have identified the securities (whether it be an individual equity like SBUX or an ETF like SCHD), but when is the best time to invest? If there is a wealth creating force that is a not-so-distant second to the power of compounding, it is dollar cost averaging (DCA).

The principle of DCA is simple: by investing the same dollar amount each month in the same securities, you buy more shares as prices decline and less shares as prices increase. While this sounds extremely elementary, by definition, you buy the largest number of shares when the market is declining or in a panic. On the flip side, you purchase the fewest amount of shares at market highs. Not only is this the opposite of what emotional investors do, it mathematically guarantees that your entry price is below average. This, in turn, yields higher returns.

Not only is DCA an elegant way to reduce your average purchase price, it also enables the disciplined investor to see bear markets as a phenomenal buying opportunity. Unfortunately, the way most investors (AKA humans) brains are wired is not one that naturally gravitates towards rationality, discipline, or patience. If you have succumbed to any investment mistakes in the past, or continue to repeat behavioral patterns not in your long term financial interest, consider working with a Financial Advisor who can assist you to devise a strategy and, equally importantly, help you stick to it through good times and bad – and ignore all the noise that often causes well intended investors to steer off course.