5 Thoughts On Diversification

September 22, 2015

2. Don’t Gamble With The Future

The Ohio State football team kicked off this season ranked No. 1 in the Associated Press preseason poll for the eighth time. However, it has failed to finish No. 1 in the previous seven times it has held the preseason top ranking. Investing is not about simply betting on the favorite. For that matter, prudent investing is not about betting at all.

The stock market is fundamentally different than gambling, primarily because the odds are in the investor’s favor in investing. Gambling typically involves a toxic cocktail, often combining games that are stacked against the player with frequent opportunities for personal decisions.

Mathematically, players are not supposed to win in gambling over time. Likewise, casinos know that individuals are likely to intervene and reduce their odds of success, instead of the other way around.

The casino takes virtually no risk in the games themselves over time. In almost all cases, in the long run, the house will always win. The games, the odds and the payoffs are all carefully designed to ensure this outcome.

House Advantages:

Baccarat: 1.17 percent on bank bets, 1.36 percent on player bets

Blackjack: 0.5 to 5.9 percent for most games

Craps: 1.4 to almost 17 percent, depending on the bet

Keno: 20 to 35 percent

Roulette (with double zeros): 5.26 to 7.89 percent, depending on the bet

Slots: 2 to 25 percent (average 4-14 percent)

Video Poker: 0.2 to 12 percent (average 4 to 8 percent)

Wheel of Fortune: 11 to 24 percent

(Source: USA Today, Vegas gambling guide: Understanding the odds - Bob Sehlinger, Unofficial Guide to Las Vegas | Published on April 8, 2014)

As long as the house has a marginal advantage, it will win over time with volume. A larger advantage simply decreases the time necessary to ensure its profit. The more each player plays, the closer the odds will get to those listed above. Obviously, some players will marginally beat the odds; however, that is a risky bet.

On the other hand, according to research by J.P. Morgan, the long-term odds of success in investing are in the investor’s favor. Looking at periods from 1950 to 2014, there were zero five- or even 10-year rolling periods where a balanced portfolio of indexes lost money. This only makes sense. The world economy grows over time, interest and dividends are created, and inflation should be expected.

In investing, the odds are in the investor’s favor if they stay disciplined in a quality global allocation over time and are typically reduced by investor intervention. Investors often sell losers and buy winners. Disciplined rebalancing adds value by doing exactly the opposite.

Investors win by staying disciplined and understanding that the stock market isn't supposed to go up every day and compound at rates that exceed global growth and dividends, which would be mathematically unsustainable over time. That would be akin to eating 8,000 calories a day and burning 3,000 and expecting not to gain weight.

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