How To Hack The Stock Market

Your secret money weapon

Want to learn a guaranteed way to never, ever lose money in the stock market?

Then today’s post is for you.

Those who have read about the magic money machine will remember this graph:

S&P 500 Returns By Year

It’s a good representation of the random walk the stock market follows every single year.

Some years are great. Some are absolute disasters. And many other times, the market keeps wibbling and wobbling, seemingly unable to make up its mind.

As the above graph is a time series, let’s try and represent the data in a different way:

What the graph above tells you is the following:

In the past 94 years, the maximum one-year loss for the S&P 500 was an astounding 43% decline back in 1931.

Make no mistake: losing 43% of your money is an absolute zinger.  After that sort of a hit, you need a return of 78% just to break even.

Over the same period of time, the maximum annual gain for the S&P 500 was an equally impressive 54%.  The year was 1933 and the market was rallying on the back of the New Deal.

If you take a broader view, the market lost money in 25 of the 94 years, or roughly a quarter of the time. However, it posted a gain in each of the other 69 years, translating into roughly a 3-1 “win-lose” advantage.

Both the distribution and probability of returns demonstrate a skew to the upside. However, to call it a rollercoaster ride would be an understatement.

Thinking In Pairs

Now let’s see what happens if we extend the investment horizon to two years.

That is, what happens if one was brave enough to put some money in the S&P on January 1st – and follow up with another investment a year later, no matter what happens in the meantime?

You’ll have to squint to see the difference, but it’s there. Those lucky enough to have caught a good stretch would walk away with an annualized gain of 41%.

Those less fortunate could lose a whopping 39%, also annualized.

Interestingly, there were only 15 two-year stretches that would lead to a loss of any principal.  In all other years, roughly 84% of the time, an investor would have made money.

But two years is still a very short stretch, at least as far as the stock market is concerned. What if we extend the horizon even further?

A Long Term View

I’m not one for suspense, so here’s a chart that summarizes the range of outcomes for an investor patient enough to invest with a 5, 10, 15, and even 30-year perspective in mind.

That means buying – and continuing to buy, no matter what happens to the market.

The 5-year period is clearly the inflection point.

Sure, the maximum annualized gains come down to 28% (in other words, the kind of returns hedge fund managers would kill for these days).

However, it’s the reduction in downside risk that’s most impressive here.  As a function of simply holding one’s nerve, the maximum possible annualized loss declines to 9%.

It’s far from ideal to lose 9% per year for five years. But compared to a 39% loss in the preceding column, the impact is dramatic.

This is why five years is usually used as the minimum time horizon for stock market investors.

By now, you know how this story will go.  The longer you stay invested, the lower the spread of returns – but the higher the probability you will end up making money.

Have another look at the second last column of the graph. Over the past century, there hasn’t been a single investor with a 15-year investment horizon who would have lost money in the S&P 500 – provided they held their nerve.

And those who were patient enough to invest for 30 years in a row would have walked away with a minimum annualized return of 9%, and potentially much, much more.

Let that sink in for a moment.  By definition, anyone who starts in their 20s has an investment horizon of far beyond 30 years.

All that matters is staying invested.

For as long as the stock market has been in existence, there have been people claiming to have the proverbial philosopher’s stone. Of course, the bummer is that the folks who actually know how to beat the stock market don’t need your money.

But that’s okay – because the only secret you need to know is out there in plain sight:

Buy. Hold. Rinse and repeat.

You simply cannot lose.

Happy investing!

About Banker On Fire

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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.

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16 thoughts on “How To Hack The Stock Market”

  1. Love how you’ve been hammering down that time in the market is the way to go.

    Just wondering: from a practical perspective, what’s your strategy for regular investments, do you have an automated setup that just contributes monthly from your bank account? Once a month or some other frequency?

    I haven’t set that up yet (except for pension salary sacrifice) and I find that the monkey brain is fighting me every time I dump my contributions in on the 1st and 15th of the month if the market has jumped on that day or one of the previous ones.

    1. Thanks A. Fundamentally, good investing is very simple. It’s not easy, but simple – and it boils down to regular, long-term investing in low-cost index funds.

      As a result, what I try to do on this blog is to deliver that message in as many different ways as possible by looking at it from all kinds of angles.

      As far as my own investing strategy, my pensions are automatic and I usually max out the ISAs at the very beginning of every tax year. So not entirely automated but with time, I’ve learned just to click “buy” without even checking where the market is. Admittedly was a bit harder this year to plonk down £40k (between my wife and me) in the stock market back in April but it’s a “muscle” that gets stronger over time.

      It’s much better to automate it entirely but sadly, not all platforms have that kind of optionality yet.

  2. Would you also say the regular contributions amounts vs the amount already invested makes a difference? I’ve been wrestling with this
    Not at the stage quite yet where I want to cash out some of my profits but pensions are at 250k Isas and SAYE at 140 k so my pension contributions are 1% a month. This also helps with the thought of a drop. A 10% drop will be made up in a year with no movement in the market. Does that make sense?

    As you’ve said before when I have 500k in there a 40 % drop will make me alot less sanguine I think but the reality is I suppose staying 100% equities is actually the right thing to do whether your contributions are staying the same or not.? It’s just making sure you have enough cash on hand to ride out the drop

    I quite like the idea of a ladder approach when I’m retired. 2 years cash 3 to 5 years in a 40/60 bond fund 5 to ten in 60 /40 and the majority kept in 100%equities

    1. I think it does. Not many people appreciate what a 30% hit on a £1m portfolio will do to them mentally.

      That being said, you’ve also got years when the market goes up 30%. If you want to ride the upside, taking it on a chin in a downturn is the price of admission.

      As you say, the way to go about it is to be 100% equities and making sure you’ve got enough dry powder to sustain a long-term downturn.

  3. “You simply cannot lose”
    True over the longer investing periods over the past century for sure but going forward, I really think you now need to factor in all the uncertainties associated with climate change. The next decade will be a make or break period.

    1. That’s what people said at the end of the last decade as well (and before that, and before that etc.): “we really need to factor in all the uncertainties associated with [fill in]”. There’s always some MAJOR uncertainty around a particular topic.

      I think capital will definitely (and already is) shift towards more sustainable companies, but that does not really bother us, index fund investors, since the market will just go up over the long-term.

      1. I agree with that.

        Climate change is a big uncertainty, but so was the Nazi threat (wasn’t a given the Allies will win), the threat of nuclear war, the oil embargo, the threat of terrorism, the runaway inflation etc etc etc

        We’ve got our share of challenges now but I would argue they are actually not as bad as what some of the previous generations had to grapple with.

        1. Time will tell, but based on all the research I have seen over the past year or two, I cannot accept the threats you mention are anywhere near the scale and magnitude of the existential threat posed by runaway climate change. There will be very few investment opportunities in a world above 2C.

          1. Whilst you may or may not be correct with respect to the risk climate changes poses, one way of looking at it from an investment risk angle is that if you are correct and we are on the verge of runaway climate change then losses on the stock market will be the least of your worries, we’ll all be fighting to the death over food. So from an investing perspective you could argue that the best reason to invest is to hedge the risk that climate change ends up not being as bad as you think and that you end up needing the returns on your investment after all.

          2. @diy investor

            I’m with Hopeful Firer on this one. Not because I don’t find climate change a threat, but because in a global disaster scenario, the last thing that will worry you is the value of your portfolio.

            However, if that disaster is averted (and I am very optimistic that it will be), the value of your portfolio will be quite relevant.

            Hopefully, we (and our respective blogs) are still around in a decade so that we can see how things have played out!

  4. Great, well written article. I noticed you showed the S&P500 above as an example – would the same apply to the FTSE100/250. I’ve been out of the market since the 2008 crash where I lost a lot. But desperately need to find some yield some where as cash is losing out to inflation. US markets look so inflated, I’m hesitant to jump into – missed the boat back in March/April time. Guess the FTSE looks more attractive, but keep thinking there is a crash coming, so hesitant to invest as yet.

      1. That would be my advice as well. I use the S&P for two reasons:

        1. Availability of historical data (sadly world tracker data only goes back to the 80s or so)
        2. Far less important, but I do have a bias for US equities

        That being said, I wouldn’t buy the FTSE 250. All you need to do is get yourself a low-cost world equity tracker and hold tight

  5. Hi BOF – would you mind sharing which S&P tracker you have a preference for? Whilst VUSA looks to be the obvious choice, it pays out dividends in USD and therefore isn’t eligible for dividend reinvestment on some platforms.

    1. Hi Raj – I use VUSA. On Vanguard at least, the dividends paid show up in sterling and so I can just use them to buy more units.

      Is this not the same on other platforms?

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