Playing the odds

Playing the odds

Jonathan Clements writes on his blog that today’s economic problems won’t lead to nuclear war. 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. 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 but we’ve been doing pretty well.

True, there have been periods—like today—when you would have been better off avoiding stocks and instead of 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 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.

Clements doesn’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 single 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.

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