Decisions and outcomes are not necessarily related. One can make a good decision that results in a bad outcome, but this does not mean the decision itself was bad. This can be represented by a simple table:

Good OutcomeBad Outcome
Good Decision
Bad Decision

Here are a few examples that come to mind:

Good OutcomeBad Outcome
Good DecisionEating a salad and not getting sick
Planning for retirement and being able to retiring early
Eating a salad contaminated with E. coli
Investing a lump sum in an index fund on the Friday before Black Monday

Bad DecisionBuying a lotto ticket and winning big
Driving drunk without incident
Speculating in BitCoin and losing
Driving drunk and causing an accident

We know that investing a lump sum now is better than dollar-cost averaging your way into stocks or timing the market by attempting to “buy the dip” (e.g., Williams & Bacon, 1993; Panyagometh & Zhu, 2016). Although lump-sum investing is the preferable decision, there is a nontrivial probability of an inferior outcome as compared to investing at a later time. If a bad outcome occurs, it is more salient than had a good outcome of equal magnitude occurred. However, this should basically be chalked up to bad luck. A bad outcome does not mean a bad decision was made.

Separating decisions from outcomes goes against our nature. It is contrary to human psychology. In her 2018 book, Thinking in Bets, poker champion Annie Duke calls the human prediction to judge decisions by the resultant outcomes “resulting.” Resulting is akin to confusing causation for correlation in science.

Making a bet where the odds are in your favor is a good decision, even if you lose. With more and more such bets, a result commensurate with the prudence of the decision approaches inevitability. In the stock market, you can think of each trading day as a bet, with these bets stacking up over time. Below, probabilities from Bloomberg data, compiled by Vanguard, show the probability of positive returns for S&P 500 investment time frames within the selected dates (1/04/1988 to 2/16/2018).

S&P 500 investment during 1/04/1988–2/16/2018Probability of positive return
One day.54
One week.58
One month.64
One year.83
Ten years.91

Although start and end points matter, the pattern has been shown to hold even over the duration of the stock market’s history, including the Great Depression. Above, we see the probabilities of positive returns averaged across all day, week, month, year, and 10-year periods within a 30-year range. A 54% chance of positive returns on any particular day increases to a 91% chance of positive returns during any particular 10-year period within the 30-year period sampled.

Of course, this data nevertheless shows a 9% chance of losing money in a 10-year span. However, if you are unlucky enough to have invested the bulk of your money at an unfortunate time, this does not mean your decision was bad—just that you happened to have a bad outcome. It takes longer than 10 years for the probability of positive returns to approach inevitability—more like 30 years. Time will tell whether the recent market peak on September 20, 2018 will require months, years, or more than a decade to overcome.

The financial industry is built on confounding decisions with outcomes. A hedge fund manager is said to be “hot,” endowed with stock-picking genius, if his speculations pay off in a given year. Even for investors who were lucky enough to pick him, their decision was certainly bad; picking a low-cost index-tracking mutual fund and sticking with it for many years is a better decision. The speculator’s success is based on chance and luck, not skill. The speculator’s decisions are always bad, although their outcomes may be good, for a time. Eventually, good luck will inevitably run out, leading to underperformance of the index-tracking mutual fund, or worse, a spectacular capital wipeout à la Enron or Bernie Madoff.

We must all take a step back to carefully consider whether a good outcome was actually the result of a good decision, and whether a bad outcome resulted from a bad decision, or from a good decision that should be repeated despite a bad outcome occurring this particular time. On the whole, as a series of good decisions lengthens, good outcomes become inevitable, and as a series of bad decisions lengthens, bad outcomes become inevitable. In making such determinations, our psychology and the limited information available may work against us.

Generally, the amount of time you are invested in the stock market determines your returns, with higher probabilities of positive and larger returns if you are invested longer. This distinguishes investing from gambling. However, you cannot have rewards without risk, and it is entirely possible to lose money in a quarter, year, or even a whole decade.

In 2018, we saw what many define as a “bear” market; the S&P 500 index, which contains stocks of 500 of the largest U.S. companies, reached an all-time high on September 21, 2018 (intraday high), but fell 20.06% from this peak by close of trading on December 24, 2018. Although it went up a bit in the last week of 2018, it was still down 6.2% for the year.

Market declines invite counterfactual thinking—thinking what could have been if you had timed the market correctly, selling at the peak and buying at the lowest point. But, timing the market transforms investing into gambling; no one can consistently beat a “buy and hold” approach. If you try to time the market, the odds are against you; your returns are more likely to be lower than if you had bought and held.

Even Warren Buffett cannot time the market correctly; he had long been saying stocks are over-priced and had been holding much of Berkshire Hathaway’s assets in cash, but plowed much of this cash into Apple, banks, and other stocks in 2018 Q3. However, he would have saved billions by waiting until December 2018. Similarly, corporate stock buybacks have been enormous in recent years, and in hindsight, most were poorly timed.

It is not comforting to look to gains in prior years as recompense for 2018’s losses. Even if you invested in 2009, you still lost money this year, despite tremendous gains in prior years. Many more of us who invested over the past couple years saw our accounts in the red this quarter, erasing all gains and even part of our principal—if we could go back and put the money in a savings account or even under a mattress, we would be doing better now.

To survive a bear market, holding for the long term is critical. Preparations should start in the good times, far before panic strikes. When you invest, you should kiss your money goodbye for at least a decade or preferably even longer; if you’ll need it sooner, it’s too risky to put in equities. The Bogleheads, followers of Vanguard’s founder, Jack Bogle, call this principle “never bear too much or too little risk.”

To ensure you will hold, not sell, in a bear market, you must have at least the following: (a) education, (b) mental preparation, and (c) free cash flow. Without mental preparation, even if you have financial education and funds available to cover your expenses without selling equities, you might still sell in a panic. Without free cash flow, you might be compelled to sell to cover your debts or loss of income. Without education, you might have all your money in one stock (a horrible risk), BitCoin, or with a financial “advisor” who is plundering your portfolio with fees.

Free cash flow can be generated by selling the conservative parts of your portfolio during a market downturn. Depending on how conservative these parts of your portfolio are, they might experience no erosion of principal at all—savings accounts, certificates of deposit, and Treasury bills/bonds come to mind. The idea of asset allocation is to maintain a certain percentage of your portfolio in equities; to stay at this percentage, you would automatically buy more stocks when the market is down (“rebalancing”), because equities have declined as a proportion of your portfolio.

When is timing the market appropriate? Some would say never, but the insidious form of market timing really is jumping in and out of the market instead of holding. Assuming that you are not bearing too much (or too little) risk, timing the market can be appropriate on the way in, if it would cause you to invest earlier, or on the way out, if it would cause you to divest later. Although there is a whole industry built around timing stock purchases based on variables such as price–earnings ratios and geopolitical happenings, these are not much better than astrology. Generally, the longer you are invested in an index fund of the whole stock market, the higher your returns. Therefore, the only good forms of market timing are the ones that cause you to be invested for a longer duration.

The S&P 500, which is about 80% of the U.S. stock market by valuation, returns an average of about 10% each year. Adjusting for inflation, the average real returns are around 7–8%. However, if you were to take a portfolio of 100% Vanguard Total Stock Market Index Fund and withdraw 10% of the balance each year, you could easily run into sequence-of-returns risk (or for short, sequence risk). You could get lucky and have many years of good returns at the start, but you could head toward a complete capital wipeout with a few years like 2018 (or worse, 2008) in the first decade of your experiment. Market timing, via refraining from divesting stocks during market downturns, is an essential tool for retirees, including members of the FIRE community (financial independence, retire early), to mitigate sequence risk. Because this approach to market timing involves holding (not selling) and extending the duration of doing so, it is beneficial or at least benign, rather than malignant.

Ten percent is nice, but neither spectacular nor guaranteed. A savings account can now yield you over 2% per year, guaranteed. With stocks, you might earn 10% in 2019, earn 25%, or even lose 40%. Although credit card companies lose money when people default, overall they are wildly profitable because they collect returns on debts that approach 30% per year. Before you invest, you should pay your credit card debts. Even mortgages and student loans with interest rates around 5% per year might be paid first before investing in stocks; this is a guaranteed return, while stocks may lose value. Of course, if your employer matches 50% or 100% of 401(k) contributions you should do this up to the cap before paying more than the minimum payments on your credit cards, but this is a rare example. Usually, money does not grow on trees.

Take solace. In an index fund of the whole U.S. or global stock market, your investment will not go to zero, and it will eventually come back up. On the other hand, if you have the bulk of your investments in your company’s stock, you could certainly lose everything. Even an entire market sector could get wiped out (e.g., fossil fuels). You can’t have rewards without risk, but you can have risk without rewards. An “investment” can be both risky and more likely than not to be a loser (e.g., lottery tickets). It is your responsibility to learn and know the difference, implement this knowledge, and follow through, especially in a bear market.

People are generally confused about what to do with excess money. The words we use to talk about this are not helpful. Most people think of saving money by putting it in a bank. However, the key to financial success is investing money by putting it in a 401(k), an individual retirement arrangement (IRA), and a taxable brokerage account to buy stocks (real estate is another option if you have the requisite expertise).

However, saving money is important. You want to have savings to cover your expenses and unexpected financial needs. But, as your financial capital grows, an increasing proportion of it should be in stocks. This is why sound financial advice advises establishing an “emergency fund,” which is savings to cover several months of living expenses, before you start investing. Another prerequisite to investing is eliminating high-interest debt, such as credit cards.

Typically, people talk about a savings account being “safe” and investing being “risky.” In one sense, this is true. With a savings account, you can’t wind up with fewer dollars than you deposited, while an investment in stocks can result in losing money. However, in the long run, avoiding investing is the truly risky maneuver. Unfortunately, half of Americans avoid investing entirely, which is financially ruinous in the long term.

The best way to invest is to buy the whole stock market via a mutual fund commonly known as an “index” fund. Instead of picking stocks or market sectors, you can invest in the whole U.S. publicly traded stock market by purchasing shares in an index fund that invests in the approximately 3,500 publicly traded U.S. companies, proportionate to their value (that is, their market capitalization). Apple is the most valuable company, so as of this writing, about 2.9% of your money will be invested in Apple, 2.7% in Microsoft, 2.5% in Microsoft, 2.4% in Google, … 0.8% in Home Depot, 0.7% in Boeing, and so on.

Index funds of the whole U.S. stock market have very low fees and a high probability of greatly increasing in value over the long term (15 years or more). Although in any particular year, there is about a 25% chance of losing money and a 75% chance of making money, over longer spans the chance of losing money approaches 0%.

Additionally, it is sensible to hold an index fund of the “international” stock market; that is, all publicly traded companies not based in the United States (for example, the Vanguard Total International index). The largest of the approximately 6,100 stocks in this fund are presently Tencent (1.15%), Nestle (0.95%), Alibaba (0.8%), Samsung (0.8%), and HSBC bank (0.75%). Of the proportion of your money invested in stocks, many people suggest putting about 80% in the U.S. market and 20% in the international market. Others recommend 100% in the U.S. market (most notably Warren Buffett) and others recommend a 50%/50% split. Considering the whole earth, the U.S. market’s valuation is about 50% of the earth and all other countries are about 50%.

Many people think of investing as “gambling.” This is not correct. The saying, “the house always wins” is accurate; when you gamble, be it in a lottery, casino, or buying scratch-off tickets, you are more likely to lose money than gain. As you gamble more and more, your probability of making money approaches 0%. Investing is fundamentally different, because the odds are in your favor—your probability of making money approaches 100% the longer you stay invested in the whole stock market.

Not investing is risky because over time, you are going to wind up with far less money as compared with someone who invests in index funds of the whole U.S. stock market and optionally/additionally the international stock market. When we talk of equities (stocks) being “risky,” if referring to the whole stock market, this risk is time-limited. Over decades, the riskier path is actually sticking to “safer” choices like savings accounts, money market accounts, certificates of deposit, and bonds.

With investing, starting earlier is better, and investing for retirement is critical. Your 401(k) and IRA can be in a money market account earning next to nothing, or in index funds of the whole U.S. and international stock markets earning large, tax-deferred or tax-free gains. The choice is yours. (Although some 401[k]s do not offer an index fund of the whole U.S. stock market, in these cases it is reasonable to invest your 401[k] contributions in a Standard and Poor’s 500 [S&P500] index fund.)

Fidelity, Vanguard, Charles Schwab, and TIAA are the largest brokerage firms where you would select to buy an index fund with low fees (i.e., 0.25% per year or lower) for your taxable brokerage account and retirement accounts. In addition to investment returns, retirement investing is important because you are offered tax reductions and credits for doing so, but you can only invest up to a certain amount each year, so if you start later, you can’t go back and contribute for previous years.

Another benefit is that the so-called “unearned” income received via investing (namely, capital gains) is advantaged over earned wages in other ways, even in a typical taxable brokerage account—for example, you don’t have to pay Social Security or Medicare taxes on your capital gains, and you can choose when to receive the capital gains by cashing out in a tax year that is advantageous to you (known as “tax gain harvesting”).

One of the biggest financial risks for young and middle-aged adults is not investing. Although two-thirds or more of Americans do not understand investing and other basic financial concepts, the information can be learned on your own, from websites and books. However, weeding out widespread bad advice is difficult. Many financial professionals are trying to sell you on managing your money with them, for their own personal gain rather than your gain. Many financial pundits talk about investing in particular stocks to the public’s detriment, because it is simply boring to only talk about investing in the entire stock market, despite being preferable.

You can learn about finance and wisely invest in index funds of the whole stock market without anyone’s help, but you must put forth time and effort. Hiring a “wealth manager” or financial advisor can be dangerous to your financial health; you must be sure they are acting in your best interests, rather than for their own profit. Demanding they conform to the “fiduciary standard,” not the “suitability standard,” is a good start. Regardless of whether you hire a financial advisor, educating yourself is critical, and will pay off massively over the course of your life.

Lottery tickets graph

As a child, I was fascinated with lottery odds. I recall that the odds of winning the Florida lottery jackpot at that time were about 1 in 14 million, and that scratch-off tickets displayed the odds of winning a prize on the back, which was usually around 1 in 4.

The above graph (drawn by me) is actually far too optimistic. The odds of overall gains are lower than 1 in 4 because a typical scratch-off or instant-win ticket counts a prize of the same amount as the purchase price as “winning,” even though this is actually breaking even. Of course, buying a $2 ticket and “winning” $2 is the second commonest outcome, behind the most common outcome of losing $2. Further, the overall odds of making money decline precipitously as additional tickets are purchased. Although the “1 in X” odds of winning X fantastic prize increase with the purchase of additional tickets, the value of the improved odds is always far below the ticket price.

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