The Games We Play with Money

By The Advocates

You’re getting older if you remember when Cliff’s Notes were paper pamphlets at the bookstore and not slang for “please summarize this”. Yeah, I remember them. Turns out they’re still around, they’re just online.

Filling in nicely for Cliff today is The Idea Farm, providing a 3-bullet synopsis of an 89-page academic paper by Hendrik Bessembinder, wherein he analyzes shareholder outcomes for over 64,000 global common stocks from January 1990 to December 2020. Masochists may read the paper in its entirety here.

In his 30-year study, Bessembinder demonstrates something shocking: Only 2.4% of stocks account for all of the $75.7 trillion in net global stock market wealth creation for that period, and only 1.41% of stocks outside of the US that account for $30.7 trillion in net wealth creation.

Picking individual stocks, generally speaking, is not a game you’re not going to win. What if you missed those 2.4% of stocks that accounted for domestic wealth creation? What if you missed just half? 

The likelihood is that you did miss them, and that’s why your portfolio needs to be diversified.  But there’s a bigger concern at play here. Why do we play these games, like stock-picking, in the first place? I now refer you to Morgan Housel’s Psychology of Money.

We’ve absorbed and promoted the idea that financial success is about intellect, and that billionaires are the smartest guys in the room. That’s not true.

Forces beyond our control have a much larger impact than we want to admit.  As Housel notes “…the world is too complex for 100% of your actions to dictate 100% of your outcomes” (pg. 28).

Your odds of becoming a billionaire are 1: 578508.  Billionaires are lucky outliers and glamorizing them offers a picture of personal finance that is basically unachievable. You’d be more likely to do any of the following than join their ranks:

  • Win an Oscar (1:11500)
  • Be drafted into the NBA (1:3333 for men, 1:5000 for women)
  • Date a supermodel (1:88)

Culturally, we have strong judgement for people in poverty, chalking their condition up to nothing more than the sum of their own bad decisions. We equate poverty and immorality. That’s also not true.

Moving to chapter two, you see that luck and risk are the comedy and tragedy of finance, forces that are flip sides of the same coin, coursing through our lives, evading our control.

Housel uses Bill Gates and his would-be entrepreneurial partner, Kent Evans to demonstrate how luck and risk factor into to extreme odds situations.

Gates had a one-in-a-million chance of inheriting circumstances that allowed him to attend one of the handful of schools in the 1970s that had a computer, to his obvious benefit.

His friend, Kent was equally smart and adept with computers. But his one-in-a-million odds resulted in his death. He died in a mountaineering accident before he graduated high school. Same odds, same influences, completely different results.

The answer then, to why we play these games, is that they make sense to us in certain times and places, based on personal experiences and plain dumb luck.  

Making predictions and picking individual stocks are risky activities, cut from the same cloth. They both provide an illusion of safety that is boldly ignorant of the risks assumed. Financial clairvoyance is not real.

Follow instead broad, researched patterns that have a time horizon long enough to be significant. Hone your sense of discipline so that you will be unperturbed by financial events. And diversify your portfolio because your chance of succeeding in individual stock picking is terrifically low. And even if you did, it was probably just luck.

Want to read more? Check out our book recommendations here.

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