Some people liken the share market to a glorified casino.
We’d respectfully suggest they are either continually buying the wrong shares, continually selling at the wrong time, investing using borrowed money, or making any number of other basic investing mistakes.
Most casino gamblers lose money. The odds are stacked in the casino’s favour, of course, so in the long-run, most gamblers end up losing.
Spin Your Way To A Guaranteed Loss
Take the game of roulette, and the most basic bet, choosing a red number or a black number. There are 18 reds, 18 blacks, and one dastardly green, the dreaded zero.
The payout for a winning wager is even money (i.e. a $10 winning bet makes a $10 profit).
The green zero number gives the casino its edge. There is a probability of 18/37 that the player wins the bet, and a 19/37 chance that the player loses the bet. The result is a 2.7% edge to the house, every single time you place that bet.
Over time, the punter will lose money. Guaranteed.
A Fresh Food Winner
Played properly, the share market is different. It is made up of thousands of individual companies. Each of those quoted companies is trying to generate and grow their profits, over the long-term.
Over time, good to great companies will create economic value. Woolworths (ASX: WOW) generated around $300 million profit in 2000, and over $2 billion profit in 2010. That’s what I call economic value.
Undoubtedly some share market investors do lose money. People have even lost money investing in Woolworths shares, despite the supermarket giant having generated all that economic value over the past 10 years.
Don’t Do This At Home
They’ve sold the shares at the wrong time.
In late 2007, Woolworths shares were trading at above $34. Around that time, the global economy was strong, inflation relatively benign, their competitors (primarily Coles) were a mess, and the future looked particularly rosy.
In 2010, Woolworths shares trade at around $27. Share market investors who bought at $34 and bailed out at $27 lost a cool 20%. It might be enough for them to turn to the casino for solace, especially as you can ‘only’ lose 2.7% on each red or black bet.
What about the investor who bought at $34 but is still holding onto their Woolies shares? They are sitting on a 20% paper loss, but since they haven’t sold, it’s not a realised loss.
Over time, if Woolworths keeps generating economic value, their shares will almost certainly rise in value.
I say almost certainly, because if Woolworths shares were richly valued in 2007, it may take a very long time (or even forever) for the share price to catch up with the company’s economic value.
Time In On Your Side
With investing, and particularly when investing in companies as great as Woolworths has been, time is on your side.
But if you treat the share market like a casino, focussing on the ever-swinging share prices and not the underlying business, you can and likely will lose money.
As leading US hedge fund Kovitz Investment Group puts it such…
“As an investor you have a choice. You can decide to invest in a business as an owner and share in the profits generated. Or you can decide to buy a piece of paper in hopes that someone will buy your paper at a higher price than what you paid for it.
The problem most investors face is that the first method takes time and patience. Also, many measure the value of a business by the daily market price of the shares.
We believe that thinking only about short-term price swings as opposed to the business operation’s performance places you in a game that’s hard to win. To play that game, you are forsaking logic and critical thinking for guessing how others are thinking and how others may react.”
Not all your share market investments will be winners. In fact, if only 60% of your share picks are winners, you still should have a nicely profitable portfolio.
How is it so? The main reason is your losers can only go down by 100%, whereas your winners can go up by hundreds or even thousands of percent.
Just ask shareholders who bought JB Hi-Fi (ASX: JBH) at their float price of $1.55 how a couple of huge winners can massively outweigh the inevitable losers. In 2010, JB Hi-Fi shares traded around $19, a cool 1225% up on their float price.
On the flip side, T2 shareholders who paid $7.40 for their Telstra (ASX: TLS) shares back in 1999, are sitting on a fine loss, and one that is hard to see them clawing back in the years ahead, if ever.
The 3 Keys To Share Market Success
There are many mistakes share market investors can and will make. But if you stick to these 3 simple rules, you should be able to rack up a decent nest-egg in the decades ahead.
1) Invest for a lifetime, not for a few weeks, months or years.
2) Keep investing regularly, ideally monthly.
3) Avoid speculating, and instead concentrate on the economic value created.
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