Stack the Money Deck in Your Favour

Successful investing is about putting the odds in your favour.  But too often, we take ridiculous money risks without understanding what the real odds are.

We gamble (a lot!) in lotteries.

We seek sexy looking IPOs (hello Facebook!) in hopes of a jackpot

We put most of our money into history’s highest performing actively managed funds

And–this is your fault ladies–we often let the man of the house have too great an influence on our investments.  

In June, 2012, the American Mega Millions Lottery was offering a jackpot of $540 million. If it’s still unclaimed, the eventual prize could climb higher. 

Some of you are probably shaking your head, figuring that lotteries and other gambling ventures are sandboxes for the mathematically challenged.  Robert Siegel might agree.  The mathematician at Emory University suggests “the odds [of winning] are about one in 175 million…you’re about 100 times more likely to die of a flesh-eating bacteria than you are to win the lottery.”

Canadians, however, aren’t immune to the costly allure of money for nothing. According to Stats Canada, in 2010 the average Canadian sank nearly $4.12 into gambling ventures (including casinos and lotteries) for every $10 we invested in RRSPs.

Striving for financial freedom is tough enough without wasting money on expensive opportunities.  But lotteries, unfortunately, aren’t the only rigged games in town.  Many investors splurge on imagination-capturing IPOs.  Story book stock offerings (like Intel and Microsoft) have certainly made their share of millionaires.  Like lotteries, however, the odds of winning are long and painful. 

When University of Florida’s finance professor Jay Ritter studied 1,006 IPOs between 1988 and 1993, he found that the median IPO underperformed the Russell 3000 index of small stocks by 30%, just three years after going public.  And nearly half of the Initial Public Offerings lost money during the study (1).

If you don’t want to buy and hold an IPO, preferring to take advantage of a short term price pop instead, you might reconsider.  Facebook wasn’t the only dreamy business disappointing public investors.  A U.S. Bancorp study of 4,900 IPOs offered between May 1988 and July 1998 revealed that 66% of the IPOs failed to rise in price. 

Almost a third of them went bankrupt, were acquired by other companies or were no longer sold on the public market by the end of the 1998 study date.  Stock purchasers have far better odds of success when buying and holding dull, blue chip dividend paying stocks, rather than pinning hopes on the IPO market.

How about the odds of something more conventional, like actively managed mutual funds with great historical returns?  Again, the odds of winning are low.  Burton Malkiel, author of A Random Walk Down Wall Street revealed in a four decade long study (starting in the 1970s) that buying the top 20 funds from each previous decade would have ensured that investors underperformed the market in the decade that followed. 

In another four decade long study (starting in 1962) author Mark Carhart found that funds performing in the top 10% in any single year were more likely to drop to the bottom 10% of fund performers the following year, rather than maintain their top 10% positions (3).  The odds of success, paradoxically, are much better when we ignore past results and seek funds with low expense ratios instead.

Finally, not embracing your feminine side (or letting the man of the house run the money) may lead to crummy investment results. University of California researchers Brad Barber and Terrance Odean studied 35,000 household discount brokerage accounts between 1991 and 1997, revealing that single women earned nearly three percent more each year than single men, on a risk adjusted return comparison.

Married men, in the same study, outperformed single men—with the potential difference being the womens’ influence. 

Barclays Wealth and Ledbury Research also found that women were better investors because they tend to be more diversified and have lower risk tolerances than men.  A 2004 Merrill Lynch study echoed the sentiment, suggesting that women know less about investing, but still earn higher returns than men.

In a study of male and female fund managers, investigators at the Center for Financial Research in Cologne, Germany revealed fund returns between the sexes were similar, but women managers traded less frequently—ensuring lower transaction costs and lower taxable penalties for fund holders.

Whether you’re male or female, embracing your feminine side or listening to the practical advice of a woman could increase your financial rewards.

Investing, of course, doesn’t come with guarantees.  But if you can stack the deck in your favour by understanding the probabilities of success, you could end up with a winning hand.

 Sources:

1. Ruth Simon, “IPOs over the Internet?  Tread Carefully,” The Wall Street Journal, Feb 24, 1999.
2. “Dow Jones Industrial Average Closes above 10,000” The Wall Street Journal, March 30, 1999.
3. Published in Mark Hulbert’s, “Why Top Returns Are Not in the Stars”, New York: Fireside, 1999, p. 86.