Is investing in the stock market really like going to a casino? In this episode of PIVOT with Darryl Lyons, Darryl breaks down the differences between short-term speculation and long-term investing, and explains why understanding those differences matters when making decisions with your money.
Darryl walks through how stocks work, why investors are compensated for taking on greater risk and how the structure of the market gives long-term investors an opportunity to participate in the growth of successful companies. He also looks at the history of investing, from the early stock market to mutual funds, the Investment Company Act of 1940 and the creation of the 401(k).
You’ll also hear Darryl explain the role dividends can play in a portfolio through a memorable cattle and milk analogy, along with why company growth, executive incentives and shareholder interests matter.
In this episode, you’ll learn:
• Why long-term stock market investing is different from gambling
• How stocks and bonds differ in terms of risk and potential return
• What the price-to-earnings ratio tells investors about a company
• How mutual funds helped make diversification more accessible
• Why dividends can be an important part of investing
• How to match your investments with your time horizon
• Why liquidity and diversification are important parts of stewardship
• How having a clear purpose can help guide your investment decisions
• Why patience can make such a difference for long-term investors
Investing is about more than accumulating wealth. It’s about understanding what your money is for and making decisions that support that purpose.
Like the podcast? Leave a review and share this episode with someone who could benefit from thinking differently about investing and building wealth for the long term.
Visit paxfinancialgroup.com to learn more about financial planning and investment guidance.
Transcript:
Make sure, of course, that your purpose of investing is clear.
Rarely do we want to invest just to accumulate wealth. Usually, there’s a purpose behind it. If you can really define that purpose with your advisor, it helps. And when we find that purpose.
It’s Really, the fertile ground for patience. Sometimes that patience is the difference between a great investing experience and not. In fact, there’s an old saying that says the stock market is a mechanism that transfers money from the impatient to the patient.
This is Darryl Lyons, CEO and co-founder of PAX Financial Group, and you’re listening to PIVOT with Darryl Lyons. We’re going to talk about money, life, and leadership. This information is general in nature only. It’s not intended to provide specific investment, tax, or legal advice. Visit PAX Financial Group for more information.
I have conviction that the best money decisions happen in a conversation. So this is the beginning of a conversation that you can take to your advisor or somebody you trust.
I want to acknowledge a question that was sent to me via social media. You can always email me your questions, Darryl at PAX, or go to Facebook or Instagram and send some questions that way as well. But the question is: Is stock market investing the same as going to the casino?
First of all, I want to acknowledge the similarities. The similarities are that we feel like the odds are stacked against us, that there’s this system that’s designed to beat us up and for us to lose money. And I suppose that is the case in day trading. I had somebody I knew recently that just lost almost all their net worth day trading.
So it absolutely can be a casino for those that have a very short-term time horizon. I think the probabilities of success are low.
The material difference is in the odds. And for long-term investors, this difference is important to highlight historically. I’ll provide the data to support this in the show notes.
The market has gone up nearly 70% of the time. So if you had those same odds at a casino, I think we would be there more often. The material difference between a casino and the stock market, for long-term investors, is the odds. The odds are in your favor historically versus a casino, where the odds are not in your favor.
That’s why they have those big buildings.
Which actually is a good segue to the topic today. Some of you guys feel like I’m dumbing things down, but I want to share this topic. You may know this stuff already, but I might highlight a few elements that you hadn’t thought of in a while.
Additionally, this is a pretty decent podcast for you to pass along to your children if they want to know about these things.
I’m going to talk about the merits of investing in the stock market long term. I’m going to do this in four different ways. I’m going to define equities, which we use synonymously with stocks. I’m going to talk about history, which is frankly something that we take for granted. I want to unpack a little bit more about how the mechanics of stocks work. And then finally, I want to discuss stewardship. So those are the four ways I’m going to outline this conversation.
Let’s start with equities, which are often used synonymously with stocks. If you see that word, they’re used interchangeably. I don’t know where that came from, but equities, traditionally, in accounting terms, and stocks generally, are defined as an investment. They’re typically one and the same. They’re a piece of ownership. A stock is a piece of ownership of a company.
You own a piece. Not enough to go into every Starbucks and say, “I want my pumpkin protein latte for free.” You don’t get that privilege as a stock owner, but you do get a lot of other privileges. Namely, that privilege is the ability to participate in the company’s success.
I want to juxtapose that with a bond, because a bond is a loan to a company that doesn’t necessarily translate to a reward if the company performs well.
What it translates into is, you lend a company, and I’ll use Starbucks as an example, $100,000. In ten years, Starbucks pays you back that $100,000. There’s no appreciation in that, but along the journey, they pay you interest payments.
Whereas a stock, you get to participate in the success of the company.
It’s also important to define what we call a risk stack, meaning that you’ve heard this before: the higher risk, the higher potential reward.
This is clearly defined in the United States governance in the way we do things. And if you look at the history of corporate law, it was a catalyst, specifically LLCs, for our country to be successful because it limited the liability and the risk of business owners and allowed them to take risk without losing their entire estate, their entire house, or their entire family.
But there is a risk profile that is important to acknowledge. And that means that if a company goes bankrupt, the first group in line is who? It’s the IRS, of course.
The second group are those people that typically lent the company some type of money. I’m pausing a little bit because you can have subordinated and non-subordinated mezzanine. It gets really technical.
But my main point is, if you lent money to that company and, let’s say, you lent it against a building, then you have entitlement to take that building. So those are secured loans.
Then the next group in line are those that are just lenders that don’t have any collateral assigned. They’ll be in line if there’s anything left.
Frankly, the IRS is going to take a chunk. Those that have liens against buildings and things are going to take a chunk. And then, if there’s anything left, bondholders will get some. Typically, they’ll get some. It just depends on the scenario. Maybe they’ll get $0.50 on the dollar. Maybe they’ll get $0.90 on the dollar. It depends on how good the attorneys work for them.
Finally, if there’s anything left, which after that there’s not a lot, stockholders might get something.
And this is important because if stockholders are the last in line, then they’re taking the most risk. And if they’re taking the most risk, then they’re entitled to the most return.
That’s the profile of stocks. And what makes them the most attractive investment in terms of participating in the whole market ecosystem is because of where they stand in the risk line.
That profile is important to understand because that is embedded in our system, in our economy, and our business, and it actually works quite well.
If the company goes under, that’s the downside. But if the business is able to control costs, build on its reputation, become profitable, take care of its customers, and manage its people, if it does that well, you participate in its growth. You participate in the returns long term.
That, frankly, has been really an incredible mechanism, which I’ll get to in the history in just a second. But I do want to touch on how they price that success.
Generally speaking, we do something called a price-to-earnings ratio. There are a lot of different ways to price companies, but the standard one that’s typically never overlooked is called a price-to-earnings ratio.
What does that mean? That means the price that you’re paying for every dollar of profit or earnings. Again, those are used synonymously.
And so, if you see a price-to-earnings ratio that’s low, then that’s an attractive buy, and Warren Buffett would call that a value investment.
If you see a price-to-earnings ratio that’s high, that might be expensive. Or, in tech companies, there might not be a lot of earnings, but there’s a lot of potential for earnings down the road.
Some people buy companies that have very high, what we call, price-to-earnings ratios, knowing that they’re not getting a lot of earnings today, but they see the potential down the road. That’s happened a lot lately, and it’s actually changed some of the dynamics of the markets. It’s very interesting. Maybe that’s a different podcast.
But the price-to-earnings ratio is one to understand, or at least to know about, because that is how the market in general determines what companies to own and what companies to not own or disown. A lot of investors will find an exit for stocks when those price-to-earnings ratios hit a certain point, and they say, “You know what? The juice isn’t worth the squeeze anymore. We’re going to go ahead and exit and find another company.”
And that’s how the market works.
But historically, let’s move to historically. I find this fascinating too because I didn’t grow up with money. So I think about, had I grown up in a different environment maybe 200 years ago, my circumstances would have been different.
My pathway to having financial security would have been much more challenging. If you don’t know the right people, if you don’t own land, if you don’t control a trade route, if you don’t have a specialized craft or inheritance, the pathway to success is really, really challenging.
I think it’s important. And as you know, I have an appreciation for history. I think it’s important for us to reflect on how we’ve gotten to where we’ve gotten.
The mechanisms for people to be able to accumulate wealth are now the pathways are just right in front of us, and we do take them for granted. And oftentimes, we default to the negative and say, “Oh, it’s a casino,” or, “The risk is too much.”
But we don’t look at the positive, which is that now we have a mechanism in which people who were maybe serfs at one time and were going to be peasants their entire lives, and their kids and their kids’ kids, now there’s a clear pathway to be able to accumulate wealth.
It really started in the early 1600s. You had the Dutch East India Company transporting spices across the waters and people needing money, pooling money together to be able to make these trips. The risk associated with not getting back and getting paid a handsome reward for coming back and then being able to sell all these spices, that was really the catalyst of the stock market.
But it was an early iteration.
Then, of course, in the late 1700s, we developed something called the New York Stock Exchange, which allowed people to have little pieces of paper that really defined their ownership in things.
It was expensive. The information wasn’t as transparent as it is today. Trust was uneven. So there were certainly problems that we had to work out. We still work them out today.
In the 1920s, 1924 specifically, was really the birth of mutual funds, which is a financial mechanism where you mutually fund an account with thousands of people across the country, and you get to own a lot of different companies, not just one.
That allowed individuals like you and me to be able to not take too much risk. We could go about our day, do our jobs, take our kids to school and go to aftercare activities, and not worry about an individual stock because we spread it out.
That was in the ’20s. That was an important financial invention.
Then, in the ’40s, there was something called the Investment Company Act of 1940 that started to really put regulations around this. That way, people were getting a fair shake. There wasn’t this group of people that were manipulating the markets.
Of course, all of these things still exist, but it really put boundaries on it. And that Investment Company Act of 1940, if you ever get in this business, you’ve got to study that act and read about it. You may forget half of it, but it’s an important iteration in our history.
The other historical, monumental, I think, event that we need to recognize is, in 1978, was the birth year of the 401(k), which wasn’t that long ago. I say, gosh, now, I mean, 50 years ago.
And I’m laughing here because if you look at 1978 to now, the iterations of what we’ve done haven’t been more defensive now, meaning that there haven’t been, that I can think of, any monumental acts that have had that material of an impact like those, with the exception of legislation that has protected the consumer.
But those particular pieces of legislation were the foundational pieces for what we have today, which is the ability of you and me to not be a serf or peasant, and our families be peasants and serfs forever.
So the third piece of this conversation I want to unpack is how this all works pretty well.
I was talking to a client the other day, and he’s in the cattle business. I don’t keep up with cattle prices, but I do know they ebb and flow and there’s risk there. And there’s certain types of cattle that, of course, price out better than others.
His thought in his business model was he’s going to breed some of these calves and then sell the calves because this specific breed sells well. So it’s a good business model.
It made me think of this: whenever you buy a stock, it’s like buying a cow. The idea is that ideally, if you take care of that cow, that cow is going to be worth more down the road, which is awesome.
So you bought it at $10,000 and it’s worth $15,000 in a few years. That’s really good. You’re excited about that.
But the other business opportunity that we often discount is the milk. The milk. And being a milk farmer has this whole different set of analogies with it. So excuse me for this analogy falling short, but I think you’ll get the point.
The fact that the milk has merit, the milk has an opportunity for that particular farmer or rancher to be able to make some money along the way as well.
And so the milk would be equivalent to the dividend.
Hear me out. A company who is on a pathway to growth is attractive for all of us to own. But a company that’s growing and paying out some of their profits to its shareholders in the form of dividends is actually a bonus in a lot of ways.
There are trade-offs in this, but we like the dividends.
A company has a lot of decisions to make. I run a company. Of course, I’ve got a lot of decisions to make with our positive cash flow.
Do we pay down debt? Do we increase reserves? Do we pay our employees more? Do we use the profits for acquiring other businesses? Or do we pay them out to shareholders?
Always these trade-offs and tough business decisions. I think it boils down to expectations. Telling the investor, “This is what we, this is our game plan.” And then once the expectations are set, people raise their hand and say, “I get it, and I’m in.”
But for many people, they love the dividends. They love the milk.
Unfortunately, over the last decade, dividends have gone down as a percentage of overall stock market profile considerably. And it’s gone down considerably because companies who used to use dividends to pay out to shareholders, they’ve now needed those same dividends to build data centers or invest in research and development.
So the dividends have collectively, by the economy, been used to reinvest and grow companies, not be paid out as much as they used to. But they’re still out there. There’s still plenty of companies that pay out dividends.
Oftentimes, if you don’t need those dividends, we just check a box on paperwork and we reinvest those dividends to buy more shares, which really helps participate in the growth of a portfolio.
Now, a cow to be worth more over time, I think it’s important that I point out there has to be incentives for that rancher to care for the cow.
And so there are incentives for CEOs and executives to grow the cows and pay out milk. Making sure those incentives are in line is important.
And 100% of the time, I say 100% of the time, I don’t know this to be true without doing some forensic accounting, but the majority of the time, the incentives to grow the company by the CEOs and the executives, very important for you to know, are aligned with the shareholders.
And so the CEOs and executives do have, it’s incumbent upon them to grow that cow or make it more valuable and pay out milk when necessary.
And finally, the last thing I want to talk about as I lay in the plane is stewardship.
So it’s important for you, if you own stocks, to steward it well. The way you steward it is, you know this already, diversified. Don’t just own Enron, too.
I think it’s important for you to match your money with your time.
So don’t take big bets, going back to the casino analogy, with money that you might need in the next few years. If you need to pay for college next year, then you shouldn’t be taking big bets with that money or buying companies that may be having more volatility.
So make sure you match your money with the time horizon you need.
Again, in the spirit of stewardship, you need liquidity. So make sure you have adequate liquidity. That way, you don’t cash out your stocks or your mutual funds or exchange-traded funds when you need it, and then you end up selling it at a time that they’re down, which doesn’t make sense.
And make sure, of course, that your purpose of investing is clear.
You know, rarely do we want to invest just to accumulate wealth. Usually, there’s a purpose behind it. If you can really define that purpose with your advisor, it helps.
I want to leave my kids some money so they can have a leg up. I want to make sure I have enough money to support my family in retirement. I want all of you, you know, all of those. Make sure that you have that defined purpose.
Again, walking with an advisor on that defined purpose is really helpful. And we need to find that purpose.
You have your liquidity, you diversify. It makes for patience. It’s really the fertile ground for patience. And so sometimes that patience is the difference between a great investing experience and not.
In fact, there’s an old saying that says, “The stock market is a mechanism that transfers money from the impatient to the patient.”
So I hope that helps you today understand how individual stocks work, your role in stewarding those, and historically, the privilege that we have today to be able to invest in such a way that we’re not all peasants.
I hope that helps, and thank you for listening. As always, you think different when you think long term. Have a great day.
Resources:
What Percentage of the Time Do Stocks Go Up? – by Ira Roth
SEC Investor.gov – Stocks: a stock gives its holder a share of ownership in a company.
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