How much should you bet on low probability “if” with a high payoff? Where do we find a high probability of acceptable returns?
There is a Singapore tradition of a huge Hongbao Toto Draw during the Chinese New Year season, for prizes of an eye-watering quantum that can be $10 million or more. Some years, you can even reserve bundled packs of tickets beforehand. This Lunar New Year, we have a $16 Million Hong Bao Draw taking place on 11 February 2022, at 9.30pm. Will you be buying a ticket?
I did so some years ago when I was at NTUC Enterprise as part of an office pool. I wasn’t intending to, but my colleague (and fellow CFA charterholder!) issued the following opinion: “The Investment Team strongly recommends that you join the office pool for this draw with $10 each. Yes, the chances of winning $10 million are about 0.001%. However, the probability of you ever earning $10 million doing this job for the rest of your life is absolutely zero. Furthermore, in that 0.001% scenario in which those of us who participate do win, you will be left doing all our work while we go on a holiday. You have till lunchtime to avoid this fate.” Within minutes, the final holdouts – the puritans and the intellectuals – walked over waving red pieces in surrender.
If we are honest with ourselves, even though we know the odds, we all feel that it makes sense to bet $10 in TOTO for the chance of $10+ million because the payoff is so large. Not mathematical sense, but instinctive sense. A windfall is the stuff of dreams and we all need a sliver of hope at times. Screw probabilities. If I win, the realised odds for me are 100%. Before my advisers faint at their CEO’s heresy, let me highlight that the operative words are “$10” and “if”.
Where do we find a high probability of acceptable returns?
In market-based investment portfolios held into the long term. Global public equities as an asset class have rewarded those who bet on it and stayed invested. Consider the S&P500, the US stock market, which is a big component of global market indices. If you had at least 15 years to not take out your money, it did not matter which year from 1928 onwards that you started investing: you would not have had a negative annualised return. In other words, despite the hell and high water of the Great Depression, dot.com bubble, and the Global Financial Crisis, markets recovered and you would not have lost money. If you excluded these events, the time frame for no negative annualised returns is shortened to 8 years. And in the “median” scenario (when you are neither that lucky or that unlucky), we are projecting the gross average annualised return for global equities including developed and emerging market equities, to be in the 7% region. It is not a windfall such that you can quit your job tomorrow, but the power of compounding returns can help fund your goals and beat inflation.
Many of us have this time horizon. Contrary to common wisdom, even retirees in their 50s or 60s should have at least some equities in their portfolio, as part of their spending will only be much later on, given life expectancies nowadays of 85 or longer. If your time frame is shorter, adding bonds to the portfolio will help to safeguard the odds, albeit at lower return rates.
Some have said that people with little money have no choice but to pin their hopes on such payoffs as in TOTO and 4D. Actually, the less money you have, the less room for error and wastage in your financial plan. With as little as $100 lump sum or a $50 monthly RSP, you can invest in one of MoneyOwl’s five Dimensional portfolios for growing your wealth (or, with a minimum of $1000 lump sum or $100 monthly RSP, in our WiseIncome portfolio for receiving passive income). Our roboadvisory platform will make this an easy decision to execute, and our advisers will be on hand to help.
So buy that TOTO ticket, but only with spare change and once in a while. Give it the attention it deserves – a gamble, no more, no less. The same applies to “gambles” on specific stocks or in complex instruments such as options, which need to be approached with care.
The right way to invest
But where the odds are in your favour – make that the core. Make it a habit, invest regularly every month and stay the course into the long term. At MoneyOwl, we suggest that the best investment philosophy is one that eschews low-probability bets. Instead, we seek mainly to capture market-based return and to keep costs low. Our selected funds do not bet on markets, regions, industries or individual stocks/bonds, but diversify globally. We do not make macro forecasts to do tactical asset allocation, but focus on long-term asset class returns. We select low-cost funds, because costs are the only certainty in any investment and they eat into returns. Put another way, we are quite boring! But isn’t that what happens when we don’t ask you to pay us to gamble with your money?
Disclaimer: While every reasonable care is taken to ensure the accuracy of information provided, no responsibility can be accepted for any loss or inconvenience caused by any error or omission. The ideas, suggestions, general principles, examples and other information presented here are for reference and educational purposes only, and are not meant to be a substitute for professional investment advice. The information and opinions expressed herein are made in good faith and are based on sources believed to be reliable but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Expressions of opinions or estimates should neither be relied upon nor used in any way as indication of the future performance of any financial products, as prices of assets and currencies may go down as well as up and past performance should not be taken as indication of future performance. The author and publisher shall have no liability for any loss or expense whatsoever relating to investment decisions made by the reader. This article should not be construed as an offer or solicitation for the subscription, purchase or sale of any fund.
This article was first written in February 2020 and was updated in February 2022.