"The market can remain irrational longer than you can remain solvent." – John Maynard Keynes
John Maynard Keynes was attributed with this powerful quote that can make many investors feel uneasy about the prospects of the stock market. Especially with a stock market starting the year painfully downward.
This quote evokes in me a feeling much like playing roulette. Winning is all based on a little white ball bouncing on a spinning wheel, landing on what are mostly black and red numbers with two green numbers. You can get what seems like a 50/50 chance of winning by betting on black or red. But there are streaks of one color that can make breaking even seem impossible.
Let me explain with a $25 bet on black.
Start with $25 initial bet. Lands red.
So you bet $50 to recover from the loss of $25. Lands red.
So you bet $100 to recover from the loss of $50. Lands red.
So you bet $200 to recover from the loss of $100. Lands red.
So you bet $400 to recover from the loss of $200. Lands red.
So you bet $800 to recover from the loss of $400. Lands red.
So you bet $1,600 to recover from the loss of $800. Lands red.
So you bet $3,200 to recover from the loss of $1,600. Lands red.
So you bet $6,400 to recover from the loss of $3,200. Lands red.
So you bet $12,800 to recover from the loss of $6,400. Lands green.
So you give up...
In gambling, there's a point that even with the prospect that breaking even seems highly likely that we just give up, potential loss is too great. While it's not a common occurrence, a red streak like this can happen.
Winning in investing is more about achieving goals like college funding, retirement or buying something big. Winning is based on a massive global economy with people and companies and the will to succeed. We have drops in the markets from time to time, but more often than not we have growth.
Looking back at the last few months, we've had one heck of a red streak. Headlines would say the world is falling apart but statistics say we're still okay and the red streak isn't validated. To me that screams that markets are oversold - which in turn means we have some opportunity here.
So this illustration is broken to relate to investments. One bad bet isn't going to wipe out the stock market and cause us to walk away from the table. In roulette, one big loss and it's all over. The biggest losses we've ever see in the US stock market have always come back. It just takes time.
Investing is NOT gambling. When you gamble at a casino, your money trends downward. The longer you play, the higher the likelihood you will lose money. Yes, some win, however the odds are NOT in your favor in the long run.
When you invest with a diversified portfolio, you're following stock markets that trend upward. The longer you invest, the higher the likelihood you will make money. Yes, some lose, however the odds ARE in your favor in the long run.
Moral of the story: please don't confuse investing and gambling, even if some brilliant economist makes a statement that sure sounds like investing is a gamble. The irrationality simply means we can't predict in the short term and need to follow long term trends.