Buy Right Sit Tight - 2019


Make Large Numbers Work to Your Advantage in the Stock Market

By Amit Rupani

We know that investing is all about numbers. Large numbers behave differently than small numbers. When you stretch small numbers to large numbers, things invariably converge to its underlying property. Roll a six sided dice five times and the average number can be anywhere between 2 to 5. But when you roll the same dice for 1000 times, the average number will be between 3.49 and 3.51. Statistically, average number will not be outside of this range. And if you continue to roll the dice beyond 1000 times, the average number will be around 3.5 regardless of the outcomes. So the average will always converge and stay very close to 3.5 as the frequency increases.

Let's look at how large numbers behave in the game of Cricket. Below is a table showing batting average of 3 cricketers.

Sachin has the highest number of One Day International innings at 452, followed by Virat at 208 innings and Shikhar at 114. Let's assume that these cricketers score either five consecutive hundreds or five consecutive ducks in their next five innings. We want to check the impact on their batting averages with big outcomes. As the last two columns shows, Sachin's batting average is impacted the least and Shikhar's batting average is impacted the most.

Now let's look at how large numbers (time periods) behave differently in the stock market. The chart below shows that $1 invested in the S&P 500 in 1950 would have grown to almost $1283 by end of 2018. Annualized S&P 500 return (with dividends reinvested) have been 10.93 percent. A normal investor may not have a 69 year investment horizon, but 30 years would be a reasonable investment horizon. Studies have shown that you pick any 30 year period from 1930 to 2018, the markets have given a return close to 10 percent (dividends reinvested) all the time. This means that in the world of stock market, the average number converges to 10 percent, if you stay invested for long-term. Let the bigger time periods work to your benefit without worrying about short-term volatility. The best thing I loved about the chart works is that for the investor who started investing in 1950 and remained invested until now, the 2000 and 2008 crashes looked like small corrections.

The father of value investing, Benjamin Graham, explained this concept by saying that in the short run, the market is like a voting machine. But in the long run, the market is like a weighing machine.

Buy right and sit tight is the no brainer concept to tackle stock market volatility.

Happy Investing!

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Amit Rupani, CFA is an Independent Investor, practices Value Investing principles, manages money for long-term wealth creation through Equities asset class. Email: rupaniamit@yahoo.com