My least favorite line in financial planning might be: “Playing the stock market is just gambling with your money.”
Yeah, it really isn’t.
First, I have to dispute the word playing. I know why it fits in this sentence. For me, a trip to Las Vegas or Macau is “playing.” You may enjoy staying at home and “playing” at online casinos…..
….but it isn’t investing. It’s fun.
Don’t get me wrong….investing can be fun too. I enjoy it. (I’m enjoying the most horrible-odds investing game of all, our “Grow Your Dough Challenge”….see how I’m doing here) I’ve also found that the more I know about it the less I see it as “magic” and the more I understand some key principles
Play the Odds
Whether you’re gambling live at a casino like Harrahs in the USA or hanging out in your pajamas in Australia at an online casino like Gaming Club, hopefully you know enough to play the odds. All games in a casino aren’t priced the same. According to Forbes, the best odds in a casino are craps, where you have nearly a 50% chance of winning. Want to play the wheel of fortune and bet on the joker coming up? The house has a 24% better chance of winning than you do.
That’s why, when I’m in a casino I play craps. Sure, it’s fun, but I also really holding on to my money.
It’s The Same With Investing
Investing also has “odds,” but they change depending on how long you invest. As an example, a savings account earning 1% interest (wouldn’t that be nice?) would hold onto your money nicely for a short term need. However, if inflation continues at 3%, you’re going to watch your principle erode over time.
Stock are the opposite. According to Vanguard, your average return in the stock market between 1926 and 2006 was 10.45%. However, over one year, your results experienced swings most of the time +/- 20% of this number (standard deviation). That means that while you might return 30%, you could just as likely return -10%. However, over a 20 year period, your average return was 11.42%. While that’s not much better than the one year return, check this out….that number usually fluctuated by only 3.34%. That means that most of the time, your returns over longer periods of time were between 14.76% and 8.08%.
I’ll take that bet. The point? There are odds with investments, too, just like at the casino. While savings accounts are horrible long term investments, stocks are rotten during the short run.
When looking into your investments, treat it like you would a casino….if you want to win at the casino. Go to the table that provides the best odds over your timeframe and invest there. It’s much more fun than just “playing” the investing game, isn’t it?