Here’s Why Investing Is Simple, But Not Easy

On the Thursday before Memorial Day weekend, Nvidia (NVDA) soared by about 25%. In raw numbers, the stock increased in value by roughly $75 in one day. 

Of course, this move would lead some people to sell the stock and take profits. Maybe you’re a trader locking in a big win or a longer-term investor raising cash, simply not pressing your luck or selling for some other reason. 

Often, some other reason for some investors is the stock just can’t keep going up. It has moved too far too fast. Intuitive thought. But not necessarily true. A temporary dip on profit taking is one thing. A sustained decline is entirely another. While it remains to be seen what will happen in NVDA’s specific case, generally speaking, long-term investors might want to fight intuition and the urge to sell big winners too soon. 

‘What Goes Up Must Come Down’

The Juice is a big fan of Canadian personal finance and investing writer, Ben Le Fort.  In a recent Medium article, Le Fort called what goes up must come down “a myth that hurts investors.” To make his point, Le Fort uses one of our favorite theories and relates it to investing. 

The Gambler’s Fallacy

Some people treat trading and investing like gambling. Today, we’re not talking about the folks who are reckless. We’re talking about everyday investors who follow their intuition to do the seemingly sane, logical and right thing. Well-intentioned or not, these investors effectively treat investing like gambling. 

Consider Le Fort’s example:

A gambler is trying to decide whether to put their money on Red or Black. They look at the electronic sign that shows what numbers have recently hit. They see that the last four numbers were all “Black,” so they bet their money on Red because they believe “red is overdue.”

Then the little white ball lands on “15-Black,” and they lose their money.

“What are the odds!?” the gambler says in amazement.

The odds of landing on Red were exactly 47.37%, as there are 38 total numbers on a roulette table, and only 18 are red. The odds of landing on Red would be exactly 47.37%, even if the last 500 spins landed on black.

Bold emphasis added on that last part because it’s important. 

Le Fort goes on to explain that people hate randomness. We’ll do anything to find patterns because patterns help us make sense of the world. However, this tendency spits in the face of basic, objective math, particularly statistics and probability. 

Relating this back to investing:

In short, the Gambler’s Fallacy leads stock pickers to underperform by selling a hot stock too soon and hanging onto a poorly performing stock too long.

Imagine you buy a stock because it has been increasing rapidly in value. You own it for 3–4 months, and the stock continues to skyrocket during that time. You think, “this can’t continue; the stock is due to come back down in value.” So, you sell the stock only to discover that it continued skyrocketing after you sold it.

The reverse situation is also common. An investor buys a stock because it’s decreased in value recently, and they believe “it’s due to rebound,” and when it does, they will ride that stock to enormous profits. So, they buy the stock only to watch it continue to lose value day by day.

Both are common examples of the Gambler’s Fallacy and even more evidence as to why investing in index funds is a more rational approach than picking stocks.

Interesting stuff to consider. 

This is not to say you should not sell NVDA or any other big winner you own. It is to say you probably should at least think twice if your only reason for selling is this can’t continue; the stock is due to come back down in value.

For the record, NVDA is up approximately 46,217% since it went public in 1999 and a more modest, but still impressive 490% or so over the last five years. 

The Bottom Line: So many of these investing conversations lead back to buying and holding index funds. A topic near and dear to The Juice’s heart. For many long-term investors, it absolutely is a more rational approach than picking stocks. 

With that in mind, in tomorrow’s Juice, we continue our analysis of passive versus active ETFs with some interesting data from the luxury ETF space. This will provide a nice segue into an installment next week where we give you some ETF portfolio ideas.

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