No, The Stock Market Isn't Rigged Against You

Be the tortoise, not the hare. Don't let sleazy salesmen persuade you that your long-term dreams cannot become reality.

Every now and then I hear people talking about the stock market as if it is some vile Wall Street casino that is totally rigged against the Main Street, mom & pop, retail type investor. This sort of narrative is oftentimes driven by “alternative facts” and sleazy advertisements proclaiming doom, gloom, and capital ruin. I hate hearing these types of messages; it’s my opinion that this cynical outlook on the U.S. stock market couldn’t be further from the truth. Sure, there are companies in the market with totally irrational premiums associated with their shares. There are small cap growth companies with huge risk/reward scenarios, beaten down contrarian picks with the potential to lead to riches or total capital destruction, and popular momentum driven names with valuations very difficult to justify with traditional fundamental metrics. Investing in these types of assets is very similar to gambling, but no one is forcing investors into these high risk scenarios. Without a doubt, every equity investment comes with risk; but, the way I see it, in today’s economy the stock market is the best chance that many retail investors have to climb the social ladder and remains a driving force behind the “American Dream”.

I listen to CNBC’s Sirius Radio channel when I drive around and I’m constantly amazed by the commercials that I hear. Yesterday I heard some guy talks about a fabulous real estate investment available for people who were interested in 12-16% annualized returns (with all sorts of guarantees on total returns and capital preservation). Illiquidity aside, I highly doubt that these deals are as attractive as they seem. If they were, there would be plenty of institutional money available and developers wouldn’t have to settle for ad campaigns that are sleazy at best and predatory at worst.

During the next commercial break another guy greeted me and proceeded to explain that he’d “lost” half of his savings in the unstable markets during the most recent financial crisis, which is why now, he only owns physical gold. He continued on, saying that there has never been a better time to buy gold and now he sleeps like a baby, knowing that even when he’s resting, his gold is still at work, producing value. I couldn’t help but laugh at this one.

The speaker lost all credibility claiming that the Great Recession ruined him financially. Investors only “lost” 40-50% of their savings if they let fear rule them and sold at the absolute bottom of the crisis. Investors like this lack the intestinal fortitude required to effectively manage money in the markets.

What’s more, his gold isn’t “working” for him at all. Gold actually doesn’t do much of anything, other than sit there and look pretty. It doesn’t grow, it doesn’t compete, it doesn’t take market share, it doesn’t produce earnings, it doesn’t pay interest; it just exists in a relatively rarefied form. Yes, I know that humans have placed a certain amount of value on gold for its physical properties throughout much of our history, but outside of a small industrial usage component, gold is little more than a speculative store of value. It’s ironic that this man was calling the stock market a casino while recommending that men and women flock to his online mint to buy shiny tokens akin to poker chips.

If the speaker in this commercial was real and held his stocks instead of selling them, he’d be sitting on solid gains from pre-crisis levels today. Obviously there was no way of knowing this in the Spring of 2009, but using the very long-term data that history provides, we see that although corrections have been fairly common, the U.S. markets have always bounced back stronger than they were before. Why? Because innovation and the ingenuity of mankind is a stronger force than fear in a capitalistic economy.

I could go on and on here with regard to doom and gloom predictions meant to scare investors out of the markets and into alternative investments, but I think you get the picture. I’m sure you’ve heard these types of claims before. And I wouldn’t be surprised to hear that several these claims have been presented so well that you might even have considered calling the phone number given at the end of the commercial for more information on the “can’t miss” opportunity that was being so generously offered to you. Greed is real and even the very best of us experience it from time to time. But, if there’s one thing I’ve learned about the markets over the years is that there is no such thing as a free lunch. I think there’s room for alternative investments in a well diversified asset portfolio, but “guaranteed” double digit returns are typically too good to be true.

I’ve produced double digit annual returns in my portfolio in every year since I began managing my portfolio except for one, but that was in 2015 when the S&P 500 was up only 1.34% and the returns just north of 7% that my portfolio generated represent one of my best years in terms of alpha. However, I’ve been lucky enough to invest through a strong bull market and going into every single one of those years, I understood that my capital was at risk being exposed to equities. While I was generally bullish on the markets, I was under no illusion that I would automatically increase my wealth.

As a dividend growth investor, I was about 99% certain that my portfolio would produce a significant amount on income for me and my family. What’s more, I was also fairly certain that the passive income that my portfolio generates would grow 5-10%, year over year. Having my income stream as an anchor to rely upon during tough times in the market is one of the best aspects of managing a DGI portfolio.

With that being said, even though the average annual dividend increase streak of my holdings is well over a decade, I also understand that dividends aren’t guaranteed either. However unlikely, any one of the companies that I could cut their dividends tomorrow. This is a risk that investors must be aware of and have a plan for. But, at the end of the day, I feel pretty darn comfortable placing my hopes of eventual financial freedom on my portfolio’s income stream.

Like the guy in the gold commercial, I’m sleeping well at night too. But, there is a major difference between us; the companies that I own are actually working 24/7, offering goods and services, competing and innovating to keep up with demand and the changing sentiments of consumers, producing sales and net income, a portion of which is oftentimes generously returned to me as a shareholder. I’m fairly certain that his pile of gold has never sent him a check.

And even if you’re not one of those people who thinks that the stock market is totally rigged against you, you might have some skepticism. I wouldn’t blame you, especially if you’re new to investing. My goal in writing this piece is to put your mind at ease (at least, relatively so). Even with all of the capital risks that come along with the market, looking back, we see that both the Dow Jones Industrial (DIA) and the S&P 500 (SPY) major market averages have produced fantastic returns for investors over the long haul. It’s rare that either index has resulted in a “home run” or “slam dunk” or whatever other sporting term one of those alternative investment commercials might have used for its product, but looking back more than 100 years, we see that investors who owned a well diversified portfolio of blue chip American companies has earned annual returns in the 7-10% range, depending on whether or not he or she re-invested dividends. And speaking of the compounding process of re-investing dividends, we also see that over the long-term, more than half of the market’s overall returns have come in the form of dividends (yet another reason to focus in on a dividend growth portfolio management strategy).

Using this great tool by DQYDJ dating back to Apr il of 1896, we see that the DIA has given investors a 5.42% annualized return without re-investing dividends and a 10.14% with re-invested dividends. I doubt that any readers were along back in the 19th century, but this long-term data speaks for itself. Using this database, I’m sure you could cherry pick dates to help validate a fearful thesis in the short-term, but in the long-term, it’s clear that the U.S. stock markets have developed a habit of moving up and to the right.

The same thing goes for the SPY, which has information dating back even further. According to DQYDJ, the SPY has returned 4.4% annually without dividends re-invested and ~9% with dividends re-invested.

I know that a 9-10% annual return might not sound exciting to certain investors, but it essentially means that your money is doubling every 7 year or so. Here’s a scenario that I think is entirely possible for many potential readers. Let’s say that you have $10,000.00 saved up right now. Let’s also say that you have the ability to add another $3,000.00 per year (or $250/month). Assuming that you receive somewhat average returns moving forward (~10% annually) from the market and you invest that initial ten grand (adding the $250 per month), in 50 years you’d have more than $5m dollars. Using this same initial investment/additional savings/annual return figures it would take ~34 years to generate $1m in the market.

Here’s a link to the compound interest calculator that I like to use. Maybe you’re more fortunate and have a bit more initial savings, or maybe you just got a new job that will allow you to put away more than $250/month; either way, it’s worth playing around with and getting an idea of the current trajectory of your financial future.

I think the most important part of this long-term thesis is the role of dollar cost averaging over time. If you aren’t familiar with the phrase, it means to regularly invest new money into the market over time. When you DCA you’ll likely end up buying some shares at high valuations near market peaks, but so long as you stay disciplined to the plan, you’ll inevitably buy shares with cheap valuations at the troughs too. Dollar cost averaging is a great method of spreading one’s risk out over a long time horizon, which will coverage a broad gambit of valuations across the macro cycles that take place within the markets. This method of regularly investing money in the markets have proven to be a great wealth building practice for investors in the past and while it’s impossible to predict future events, I expect for it be successful moving forward as well.

Unless you’re already sitting on a mountain of cash, you’ll find that when using a 7-10% annual return it’s pretty difficult to find yourself becoming a billionaire and if that’s your goal in life then maybe you ought to take outsized risks involving more speculative risk/return scenarios than the blue chip stocks & the broader market indexes provide. But, if your goal is a respectable nest-egg that leads to a comfortable retirement, I think it’s entirely possible to achieve a an acceptable using realistic earning/savings power and annualized market return projections.

This all sounds pretty boring doesn’t it? That’s the point. The stock market is a tortoise’s race, not the hare’s. It’s entirely possible to get rich, slowly, owning a well diversified basket of assets such as the SPY. This isn’t what the guys and gals in those commercials want you to hear, but it’s true. In a non-apocalyptic scenario, it’s difficult to imagine a future where the major U.S. indexes aren’t producing wealth for shareholders. And frankly put, if the world goes to hell in a hand basket, it won’t matter much whether you chose to invest in stocks, bonds, golden bars, bitcoin, and the like, so what’s the the use of financially planning for that sort of future in the first place?

Obviously you can make investing as sophisticated as you like. This article didn’t even touch on basic value investing principles, which can also help investors stay out of trouble with regard to speculation and the gambling within the markets. I was planning on covering that here but I’ve already pushed past 2,000 words and I’m sure your attention span is wearing thin. That’s alright, I’m never opposed to putting together a series. Up next I’ll cover basic fundamental analysis, but until then, enjoy the resources provided in this piece and remember that over the long-term, the market has been a wonderful vehicle for wealth creation for patient investors…contrary to what any snake oil salesmen might lead you to believe.