Are you gambling or investing?

 

Wouldn’t it be great to know on January 1 which type of investment would be the big winner over the next 12 months? Will it be large company stock, or small international companies? Maybe high quality bonds will outperform, or will it be their riskier high-yield cousins?

I’m always amused as the end of a year approaches and I start to see the various predictions about which investment is poised for a breakout performance the next year. It seems everyone has an opinion.

Rarely do I see an analysis of the previous year’s predictions, though. Probably because so few of the predictions come true!

Each year Callen & Associates publishes an updated “Callen Periodic Table of Investment Returns”. Formatted much like the dreaded periodic table from high school Chemistry class, it ranks ten different types of investments in order of performance. Each class is assigned a unique color so one can easily see where it ranked. The best performing type is at the top, the worst is at the bottom.

The current version of the Callen Table shows the ranking for each year between 1996 and 2015, a twenty year span.

gambling or investing

Can you see a predictable pattern in the year-to-year returns?

I hope you said “No”, as there is no pattern! Notice how last year’s winner is often (but not always) near the bottom the following year (or last year’s loser is near the top the next year). History clearly shows us that there is no way to accurately – and consistently – predict which type of investment will top the others.

Nevertheless, many investment advisers will attempt to steer their clients into a particular asset class that they feel will outperform the others. A little math calculation shows that if an adviser accurately predicted each year’s top performer for the years shown above, he would have turned a $10,000 investment in 1996 into over $1.35 million by the end of 2015.

Not bad! Not possible, either.

If the analyst could accurately pick that year’s “best in class” investment for twenty consecutive years, they wouldn’t be an analyst – they would just invest in their prediction!

What are the odds?

Think of it this way: with ten investment types shown in the table, there is a 10% chance of guessing the top performer in Year 1. There is a 1% chance of picking the top performers for both Year 1 and Year 2. After just five years (not the twenty years shown in the table), someone would have only a 0.001% chance of accurately predicting all of the five years.

To put those odds in perspective, a gambler has nearly a 1% chance of winning six hands of blackjack in a row. If your odds in Las Vegas are 1,000% better than your investment plan, you many need to rethink your strategy!

In reality, no one predicted these results. And no one will over the next twenty years, either.

So what do we do?

I’ve accepted the fact that I’ll never be able to consistently guess (and it would be just that, a guess) which type of investment will be near the top. So I invest in them all. If I purchase a total US stock, a total international stock and a total bond market index fund (or ETF) I have hit all of the investment types shown, and a few more! Plus these types of funds are very low-cost and tax efficient. Even more to love.

Then, when I re-balance these funds, I’m selling funds that have done well (“Sell high”) and buying funds that have done poorly (“Buy low”).
My advice is to stop trying to outsmart the market. You won’t. Professional money managers and hedge fund operators can’t do it. Why would you or I think we could?

Instead, follow sound investment principals. Diversify across many asset types. Keep your costs low and your tax bills lower. Focus on the long-term results, not year-to-year performance winners.

Investing really can be that simple and straightforward!  Make sure you know whether you are gambling or investing!

 

Contact me if I can help answer any questions you may have.

 

Are you gambling or investing with your portfolio?

 

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