If predicting the future is tricky, where does performance come from? Or is it all just some deeply confusing magic box where you drop money in the top and hopefully see more money drops out the bottom?
In 2004, Ashley Revell, from Maidstone, in Kent, sold everything he owned, went to Las Vegas, bet everything (around £76,000 at the time) on red, and…won. What is interesting about that is that if you google “bet everything and won” you get multiple high-profile stories about Ashley, whereas the opposite search, “bet everything and lost” is a far less uplifting and far more diversified litany of many destroyed lives.
The wrong sort of risk comes home to roost sooner or later, usually sooner. Even Ashley himself in an article about his experience looks back on his younger self with a measure of disdain and wonders why he did it. His success was purely and obviously dependent on luck.
So, if it isn’t easy to make accurate predictions of the future, what’s to be done to ensure that your long-term plans aren’t just subject to the continued successful rolling of dice, albeit less obviously than Ashley’s?
Within the capitalist framework, risk is important. It isn’t often possible to create new markets or even grow your existing customer base without taking some commercial risk, but as an investor, the better risk to take is market risk, where there isn’t any practical likelihood of your money evaporating to nothing. ‘The value of your investment can fall as well as rise’ sounds like a scary warning, but the individual share warning of ‘investors may lose their entire capital’ is a lot scarier, and rightly so.
Diversification is known as the only investment ‘free lunch’, and as such we love it. Why buy one company share, when it’s safer, easier, and can even be cheaper, to own a bit of all of them?
But other than risk mitigation, what are we trying to achieve by diversifying? Are we not ensuring mediocrity? Well, let’s examine that. In reality, market performance is anything but mediocre.
Over the long run (80 years in this case, I think we can agree that’s long term, from 31/12/1940 to 31/12/2020), an investment of $100 into the US S&P500 index would have grown into $610,950. Even after we apply the ravages of inflation to that number, you can still buy 331 times as much as you could 80 years before. That’s a decent return by any measure, albeit one you have to wait for, and at no point in that time have you taken a speculative risk with your capital that could see it marked to zero.
So, back to the title; where does this growth come from? You. It comes from you, your colleagues, your friends, neighbours, and people you’ve never met. Everyone who is involved in the economy, which is to say, almost everyone.
When something is dug up, or grown, and processed, it is usually made more valuable, and that increase in value is usually more than the processing costs. When someone has a new idea, which gives rise to new products, new markets, entirely new industries (AI anyone?) they are creating enormous value from thought and work.
All of this, from the smallest incremental improvement to the fundamental creation of new businesses is accretive and adds to the world’s bottom line. And due to the miracle (not always perfect, but the best solution we have) of capitalism, we as investors can participate in the process of these improvements, and see our money grow as a consequence.
That is where growth comes from, and whilst we never know when markets will choose to hand out the profits, it is a far more reliable style of investing than trying to pick winners and outcompete everybody else doing the same thing.
