What Do Equity Investments & Russian Roulette Have in Common?

I’ve never played Russian Roulette. As I understand it, the game involves loading a bullet into one chamber of a revolver, spinning the cylinder, and then, without looking to see what comes next, putting the gun to your own head and pulling the trigger.

In a six-shot revolver, the player has a 1-in-6 chance of killing himself, which is about 16.67%. Even though there’s only a small chance of you killing yourself, the game is still not worth playing.

I look at the financial markets in much the same way, but with a twist.

Equity investing is a game that most of us “play” so that we can meet our financial goals. Knowing that no one is more interested in our success than we are, we spend a lot of time planning our investments and then monitoring their performance. We also do a lot of research, and find that many experts tell us the best thing to do is buy well-known companies or index funds and simply hang on.

That seems like Russian Roulette with my money, only worse.

I know that, on average, U.S. equities have returned 9% over the past [90 years]. Looking at the S&P 500 since 1950, the index lost more than 20% or more on nine occasions, and lost 30% or more five times, which equates to about a 10% chance and 5% chance of loss, respectively.

Granted, unlike Russian Roulette, the markets eventually recovered after each loss and reached new highs, rewarding those who stayed invested. Based on this little bit of information, dumping all your excess funds into the markets and letting them ride seems like the best option… but things are never as simple as they seem.

In the game of Russian Roulette, there are just a few variables. There is one bullet. There are six chambers. The outcome is binary — either a shot is fired or it isn’t.

In the world of finance and equities, the list of possibilities is endless. Central bank actions, wars, new discoveries, corporate fraud — all of these and more can change the course of the equity markets. Every day that we stay invested is another day that we leave ourselves open to the possibility that an unexpected outside force will push the market higher, or drive it lower.

Anyone remaining in the markets 100% of the time, based on the idea that it always comes back and always goes higher, is making the bet that nothing new will ever happen… like a central bank printing $4 trillion dollars… or the largest generation in history demanding its entitlement check from the government… or central banks around the world creating the biggest bond bubble in history.

Call me crazy, but I think new things are always possible, and not always good.

As investors, we can’t afford to bet our lives on an average, because we each have our own individual needs to consider. While we invest to grow our holdings to protect our standard of living in retirement as well as meet other goals, our timing has limitations. We might be able to put off retirement for a few years, or move up when we replace an aging car, but by and large we can’t put off major life events — which take chunks of cash — for too long. This lack of flexibility might force us to withdraw funds from the markets just as they suffer one of those low-risk, high-loss events, much like people who retired in 2008 or 2009.

This gets to the heart of the issue. Equity investing is essential to most of us who are trying to grow our wealth, but the risks involved, even though they have a low chance of happening, can be both unforeseen and devastating to us personally. When a metaphorical meteorite lands right in our portfolio, where will all of the “just buy index funds and hang on” experts going to be? They will be penning a piece about how they didn’t see it coming.

Great… thanks for nothing.

I understand the logic of buy-and-hold, but I also know the risks. That’s why my equity investments tend to be short-term in nature, using proven strategies with quantifiable risk, which is a fancy way of saying I invest where I see gains, and I’m willing to sell to protect my money.

People are free to choose whatever approach they want, but without a system that indicates when to get out as well as when to buy, you’re betting nothing new will happen, and that the law of averages will work out in your favor.

Those aren’t bets I’m willing to make.

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Rodney

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Categories: Investing

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.