Now available: The highest rate of return ever!
I’m often asked, “What’s the top investment?” If by “top” you mean the one with the highest potential return on investment, the answer is simple. And you can get in on it today while that potential return is at its highest level in history.
The answer may be obvious to you with all the recent hype. It’s a ticket in the Mega Millions lottery. Of course, it should be called Mega Billions because for just $2 you get the opportunity to make at least $1.6 billion!
What’s the rate of return on that? It’s as close to infinity as any return we have ever seen.
And it doesn’t matter whether you invest $2 or $100; the payoff in terms of return percentage is still almost infinite. In other words, you don’t have to empty your bank account for a chance to earn that rate of return.
Of course, you can increase your odds of winning if you do spend all of your savings on tickets for Tuesday night’s lottery. So why don’t we?
Three reasons: First, the odds are so against you winning. Since the lottery officials changed the rules last October to make it harder to win, it’s estimated that the odds of winning are at least 302,575,350-to-1. That’s less likely than being hit by lightning or going down in a space capsule!
Second, putting more money into such a giant pot of entries does not change your odds of winning in any real sense. Investing $100 changes the odds to 3.02 million-to-1. Feeling lucky?
The third and final reason for not rushing out and putting all of your net worth into lottery tickets is perhaps the most important: It’s the payoff if you don’t win the big prize. Yes, there are minor prizes—some in the million-dollar category if you don’t win the big one—but the odds against them are also in the multimillion-to-1 category. And the likely loss is … everything—100%.
I know we were all brought up on fairy tales. You know the ones I’m talking about. The lowly commoner is given the opportunity of a lifetime: Kill the (insert giant, dragon, or some other frightening menace here) and win the gold and the hand of the princess or die trying.
I guess some would take the bet, depending on their skill and circumstances in life. But I would wager that the average investor, even those with a fairy-tale upbringing, would not. They’re not going to risk everything they own and bet their net worth on the lottery, even with the highest potential percent return ever.
Investment or speculation?
This, of course, is why most financial advisers would not call buying a lottery ticket an investment. At best, they’d call it rank speculation.
What’s the difference? Mark Twain wrote, “October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.”
The way that the stock market is acting this month, it seems Twain had some good advice, at least to begin with. But recall that at age 58, Twain went bankrupt, and it was not from “speculating” in stocks.
Benjamin Graham, history’s biggest value investing proponent said, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” This is consistent with Henry Ford, who wrote, “Speculation is only a word covering the making of money out of the manipulation of prices, instead of supplying goods and services.”
In more modern times, John Bogle, the person most often credited with building Vanguard into an investment giant, has always counseled “Be an investor, not a speculator.”
Investopedia says, “The main difference between speculating and investing is the amount of risk undertaken in the trade.” And I think this gets to the real sense of it. In addition, as others have pointed out, a speculator bets his money on an unlikely big profit, while an investor invests his money for a more certain or consistent profit.
It’s all about risk
The bottom line is that you can’t talk about the amount of return on an investment without also talking about risk. This is not just in differentiating “speculation” from “investment.” It is also necessary in evaluating different types of investments: bonds from stock, balanced from aggressive, active from passive.
So often advisers and clients will ask why an account of an investor with a suitability rating of conservative, moderate, or balanced is not doing as well as the S&P 500. Of course, the answer is all about risk. The S&P 500 has fallen 55% or more twice in this century. Investors with these more risk-averse suitability profiles can only tolerate sustaining a 5% to 15% maximum loss. Why compare them to the S&P 500?
The same goes for active versus passive investing. You can’t invest with one foot out the door to manage the risk and match the return of the S&P 500 when the market is going straight up.
Once again, to be meaningful, you have to take risk into account when talking about return.
Skill vs. chance
Of course, there is an additional element that must be considered in terms of classifying these expenditures. Such an outlay of money may be neither an investment nor a speculation. To some extent, the former and the latter can involve a level of skill. Even speculators normally have some rationale for their speculation. For example, if they consistently make money picking junior gold mining stocks, where most others lose everything, the profit from their speculation is probably due to their skill, not just luck.
Gambling, however, is different. With gambling, winning is just a matter of chance. That’s why I recited the incredible odds against winning the lottery. There is no skill involved in winning the lottery. It’s all random. It’s simply a lucky beating of the odds, because the odds are that you are going to lose whatever sum you bet.
I think that at some point even an investment in a passively managed portfolio of stocks is a gamble. The odds of a market going up get smaller and smaller as stocks get pricier.
Historically, stocks do not go up forever. They go through periodic down cycles. When they peak, even indexes as skillfully constructed as the Dow and S&P can have much of their value evaporate.
Why? Because even though the index construction is skillful, the management thereafter is not. Passive index investing is a one-decision investment. You create a portfolio, and then all you can do is hold and hope. That sounds like what all of us will be doing with our lottery tickets Tuesday night—holding and hoping.
Improving the odds with a dynamic, risk-managed portfolio
While this is all that we can do when we buy a lottery ticket, it is not the only avenue available to investors. Instead of a passive indexed portfolio, we can invest all or part of our assets in a dynamic, risk-managed portfolio.
Dynamic, risk-managed portfolios give us an alternative to holding and hoping. We can skillfully employ a wide number of plan Bs to deal with the investment environment, whatever it might be.
It might seem extreme to compare passive-index, buy-and-hold investing to gambling. And I would not do so at a market bottom, or even part way up to a bull market high, or even partly down toward a bear market bottom. But 10 years into a bull market, considering the average bull market lasts four to seven years, does make one think, “How long can this bull market continue?”
Even John Bogle, the man I call Mr. Buy and Hold, the guy who never saw a Vanguard fund he didn’t like, has said in commenting on the best rules for investors, “The most important of these rules is the first one: the eternal law of reversion to the mean (RTM) in the financial markets.”
Reversion to the mean means that nothing goes up forever but instead will eventually fall back to its average and usually below. I like to compare it to filling a glass with Coke. At first, it fizzes up to the top, but then the fizz evaporates and we’re left with a glass half full.
At this point in the market cycle, is buying and holding stocks and bonds any different from buying and holding a lottery ticket? I think there is at least one major difference: We don’t know how much farther this bull market has to go. There doesn’t seem to be a recession on the near horizon. So there could be plenty of profits left to be had.
Still, it does seem like now is a particularly opportune time to hedge that gamble by adding something that can employ skill to create a plan B for one’s investment portfolio. Adding or substituting dynamic risk management can improve the odds and reduce the risk, returning your portfolio to “investment” status.
And, please, if you have not already, buy a lottery ticket today. It will add to the jackpot I’m going to win Tuesday night! I’m just sure of it!
Market update
October has, on average, been the most volatile month since we began keeping records on the S&P 500 in 1928. This October is not proving to be an exception. The only surprise is that, with an ongoing 7% price retracement, it’s actually been less volatile than it has been, on average, in past Octobers.
Still, both the Dow and the S&P finished the week higher. While, together with the NASDAQ, they are down for the quarter, all three remain in positive territory year to date. On the other hand, bonds joined the developed (EAFE) and emerging (EMM) foreign markets, in being down last week, this month, and this year. Gold is the standout, being up for the week and month, but it has fallen year to date.
The following chart of the S&P 500 is daunting. While we could be forming a bullish rising wedge, an “ice-hole failure” at either the 50-day or 200-day moving average is also possible.
An “ice-hole failure” is a pattern popularized by the late, great technical analyst David Elliott. (David passed away in May 2012 after a lengthy battle with cancer. He has been missed.) The pattern is based on the premise that when one falls through the ice, you tend to bob back up, only to be met by the ice overhead. An “ice-hole failure” pattern requires a break of a moving average (typically the 50- or 200-day) followed by a bounce back up to that average, before a plunge to lower lows. This means that the current levels of both averages are extremely important to the continuation of the long-term bull rally.
The S&P has dropped below both moving averages in the last two weeks. Friday (10/19) it moved back above the 200-day moving average, but today it dropped back below. Of course, we are now far below the 50-day moving average, and it will be important to see if we can break through and stay above it on any new bounce in prices.
It’s encouraging that a break below the 200-day moving average is not what it used to be. Here’s a chart from Bespoke Investment Group of the aftereffects.
While the chart pattern seems intimidating, our strategies have not yet pulled the plug on this rally. It is true that all of our strategies that employ leverage have reduced their exposure to less than the market’s risk level over the last few weeks. And that’s been a good thing. But our market-timing indicators continue to favor equity investments.
Our regime indicators have continued in the same stages as last week. All-Terrain is supportive of the bull market, as is volatility. But the volatility regime we are presently in also is the most volatile equity stage. It moved into this stage at almost the top of the recent market move. Nice timing!
Earnings reports accelerate this week as approximately one-third of the S&P 500 companies are expected to report. As we said back in September, history suggests that the lack of positive reaction experienced on earnings reporting days in the second quarter has so far been maintained during this quarter. In fact, reaction of the market to a company’s earnings report on the date reported during this quarter has been the worst since the second quarter of 2011, when the market was correcting nearly 20%.
Economic reports were split down the middle last week: Seven fell below expectations and seven rose above. The real excitement was in the Leading Indicator’s report, which came in higher than the previous report, but as expected.
The reason for the excitement was that the leading indicators provide a lead on a recession. At this time, they are suggesting that a recession is extremely unlikely to begin until at least the last quarter of 2020!
This causes me to continue to believe that the current market dip is likely to expand into no more than another correction, like in the spring. So the best advice I can give is to sit tight and let the disciplined systems of our various strategies do all of the work for you.
If you need to do something, buy a lottery ticket. Better yet, buy one for both the Mega Millions and the Powerball drawings this week. Winning both would get you more than $2 billion on a four dollar investment. What a rate of return! Of course, the odds of doing that are one in 75 quadrillion—that’s 75 followed by 15 zeros! Good luck!
All the best,
Jerry