Playing the Odds

Jonathan Clements

ON WALL STREET, there’s a story—apocryphal, I suspect—that’s told about an old trader, a young trader and the 1962 Cuban missile crisis.

Old trader: “They say this could lead to nuclear war.”

Young trader: “So we should buy bonds, right?”

Old trader: “No, we should buy stocks. If we don’t get war, the stock market will rally. And if we get a nuclear war, it won’t matter what we own.”

Today’s pandemic won’t lead to nuclear war (except perhaps in the Oliver Stone movie version). But many folks seem to fear the economic equivalent: that we’ll suffer a downward GDP death spiral that sends us back to the Stone Age.

Needless to say, this would not be good for share prices. But do you imagine you’d be any better off if you had your money in bonds, Krugerrands or certificates of deposit? Let’s face it: If the economy ceases to function, it won’t matter what you own. What if the economy recovers, which everybody—except your crazy uncle—expects will happen eventually? Stocks will go up.

In other words, owning stocks is an asymmetrical bet. As with bonds and cash investments, the most we can lose in the stock market is 100% of our investment. But with stocks, your potential gain is far larger. In fact, it’s infinite. To be sure, we haven’t yet reached infinity—and even the most bullish Wall Street strategists aren’t anticipating that any time soon—but we’ve been doing pretty well. Over the past 100 years, the S&P 500 has climbed 1,573,425%, including reinvested dividends.

True, there have been periods—like today—when you would have been better off avoiding stocks and instead going long cash, hand sanitizer and toilet paper. But these periods typically don’t last more than a year. Indeed, to profit from a stock market downturn, you need to be right not only about the direction of share prices, but also in your timing. History tells us that almost nobody is consistently smart enough or lucky enough to succeed with such bearish bets.

That leaves the rest of us—we poor wretched souls who are neither clairvoyant nor preternaturally lucky—to do the sensible thing, which is to play the lopsided odds offered by the stock market’s asymmetrical bet. Over time, we should allocate as much as we prudently can to stocks, knowing that we’ll suffer occasional rough patches, but also knowing that the stock market’s long-term direction is up.

That doesn’t mean we should stash everything in stocks. If we have money in our portfolio that we’ll need to spend soon, that should be in conservative investments, so our spending plans aren’t derailed by plunging share prices. Similarly, if we’re nervous investors, we might keep more in bonds, so our portfolio’s short-term performance is less erratic.

But even then, a significant portion of our portfolio should always be in stocks. At times like this, the clever cocktail crowd might view such optimism as naïve and unsophisticated. But guess what? In the financial markets, optimism—or, at least, prudent optimism—invariably wins.

How can I be so sure? Forget about economic growth, dividends and corporate profits—the usual reasons given for owning stocks. Instead, simply look around. Consider how people are behaving during this extraordinary period. Here are just five examples of what I see:

  • I’m a member of the Barnes Foundation, the fabulous museum in Philadelphia. The museum is closed because of COVID-19, but every weekday an employee posts a video discussing one of his or her favorite paintings.
  • Across the country, protesters are demanding that governors allow local businesses to reopen.
  • As Peter Mallouk discussed in a recent article, scam artists have rushed to take advantage of the pandemic.
  • Unable to compete against each other in person, professional basketball players have faced off in long-distance games of HORSE, trying to make baskets from different locations on the court.
  • Where I live, barbershops aren’t considered an essential service and should be closed. Yet my local barber—a hardworking Russian immigrant—is open, wielding his scissors while wearing a mask.

What do all these folks—some inspiring, some misguided, some larcenous—have in common? They’re trying to make the best of a bad situation. It’s who we are as humans. We’re relentlessly driven to make our lives better. This impulse is especially strong in capitalist societies, because it’s often further incentivized by the prospect of financial gain. It’s the reason I’m fully confident we’ll recover, and probably recover with surprising speed, from the current economic slowdown.

Want to benefit from this relentless drive? That’s why we invest in the stock market.

I don’t know which stocks will fare best in the months and years ahead. Some companies—both privately held and publicly traded—will never recover from today’s economic shock. Indeed, with any one individual stock, we could end up on the wrong side of the asymmetrical bet and lose 100% of our investment. Even entire national stock markets (hint: Japan) can struggle for decades.

But those who bet on the global stock market for the long haul have never lost 100%. For these investors, the asymmetrical bet has always been a winner. After every stock market decline, share prices globally have recouped their bear market losses and then headed higher. Every single time. Want this upward trend to be your friend? The formula is very simple: Buy stocks. Diversify broadly. Wait patiently.

In addition to editing HumbleDollar, Jonathan is the director of financial education for Creative Planning, which is where this article first appeared. Jonathan and Creative’s president, Peter Mallouk, together host a monthly podcast. Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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3 years ago

Outstanding article, and something many of us needed to hear right now. Please keep doing the great work you are doing, Jonathan.

Pavel Svinchnik
Pavel Svinchnik
3 years ago

I’m still buying and selling stocks but just in case everything falls apart, I have some junk silver coins for trading with the locals, beans and rice (which don’t need refrigeration) to eat, plus guns and ammunition to allow me to hold on to the above items. Hopefully, things will recover without going through a “Mad Max” phase.

Richard Gore
Richard Gore
3 years ago

I agree that the bulk of one’s investment should be in stocks, but there is no guarantee that stocks will go up from here even in a recovery. I think it is possible that even though the world doesn’t end, stocks may be a very poor investment for the next 20 years. The future is uncertain. It is necessary to prepare for alternative scenarios. Hence, it might also prudent to hold a fair amount of alternative assets, like cash, high quality bonds, residential real estate and even gold. It seems that the focus of investment planning should be on asset allocation across a variety of asset classes, not just promoting stocks.

3 years ago

Over a 20+ year time frame, the probability of losing money in the stock market is historically very low. Japan since the 1980s is an outlier, but even there you would have made some money over most 20-year holding periods:

3 years ago

You might want to take that smirk off your face. “Holding stocks” wouldn’t have done you much good between 1929 and 1954, would it? Huh? Oh and while you’re busy telling us that “stocks always go up over the long term”, I guess you would like us to consider the indices in support of your argument, right? Well perhaps it would thrill you – and your readers – to know that THERE IS NOT ONE SINGLE STOCK REMAINING IN THE DOW 30 SINCE INCEPTION. Yep. All dead. The last one, GE, died a few months ago. So much for your 1,573,425% gain in the S&P.

The stock market is a scam. It’s designed to fool you into thinking you can make money in it. Don’t believe a word of it and keep your money safe or at least in investments over which you have some modicum of control.

Steve Spinella
Steve Spinella
2 years ago

I’m reading this article, posted here 8 months ago, at the end of 2020. 8 months ago I was thinking about the same as the author, although the possibility of economic collapse seemed larger then than now, so I kept investing. Now the possibility may seem smaller, but since it is a distant possibility, in fact its likelihood is probabilistically essentially the same both then and now. Some invest because they are optimists, but realistic pessimists can still be committed to investing. I’m more of a realistic pessimist. An optimist in an economic disaster zone might be the one who thinks that their gun will protect their rice and beans, because most of their life will somewhat resemble what it is now. When I look at people who are actual refugees, they usually trade guns et al for rice and beans, which they ate yesterday, although we’ve all heard the story about the homeless man who dies with nothing though he is actually rich.

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