Gambler’s Fallacy in the Stock Market – A Wealth of Common Sense

[ad_1]

These are the trailing total returns for the U.S. stock market¹ over various time frames:

Year to date: +11%

One year: +30%

Five years: +94%

Ten years: +223%

Fifteen years: +679%

Not bad considering we’ve had two bear markets in the past four years.

If you put $10,000 into the U.S. stock market five years ago, your money has essentially doubled:

Now look at the returns by year:

2019: +31%

2020: +21%

2021: +26%

2022: -20%

2023: +26%

2024: +11%

The bear market in 2022 was painful but seems like a distant memory given the strength of the market ever since.

Since the start of 2019, the U.S. stock market is up more than 16% per year.

Looking at these numbers, it seems that we should be due for some bad returns or, at the very least, a pause in the action.

Markets are cyclical. Bad stuff tends to follow good stuff and vice versa…eventually.

We can’t expect the good times to last forever but you can’t set your watch to these things. The stock market is random, especially over the short-run. Just look at the calendar year returns for the S&P 500 since 1928:

They’re all over the map.

You can’t predict what’s going to happen next based on what just happened. Investing would be a lot easier if you could but it’s not.

A coin is no more likely to come up heads just because tails has hit five times in a row. Just because the roulette wheel was red ten times in a row, doesn’t make it any more likely than usual that black is coming up next.

The gambler’s fallacy is the belief that random events are more or less likely to occur because of the outcomes of previous events.

Look at how this plays out in the stock market:

There’s no real predictive power based on what happened previously.

Sometimes good years lead to bad years. Sometimes bad years lead to good years. Sometimes good years lead to good years. Sometimes bad years lead to bad years.

Mean reversion can be a powerful force in the stock market.

But over the short-run things are still pretty random when it comes to market returns.

Michael and I talked stock market performance in recent years and much more on this week’s Animal Spirits video:

Subscribe to The Compound so you never miss an episode.

Further Reading:
30 Years of Financial Market Returns

Now here’s what I’ve been reading lately:

Books:

¹I’m using the Vanguard Total U.S. Stock Maret ETF (VTI) here.

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.