Ben Carlson on Why the Stock Market Is the Best Casino in the World

0:04Ben Carlson:So I decided to use this parable of the guy who's a world's worst market timer. And I said, what if he only bought before 50 % crash in the 1970s, the 1987 crash, and right before the dot-com bubble blew up and right before the great financial crisis. He only bought then and he sat in cash between then, but he held onto his shares. How would he have done?

0:30That was Ben Carlson of Ritholtz-Wolf Management and the author of the upcoming book, Risk and Reward, How to Handle Market Volatility and Build Long-Term Wealth. I'm Robert Prokamp, and today is part one of my conversation with Ben about what we can learn from the Great Depression in Japan, how even the worst periods for investors eventually turn out fine over the long term, and how diversification can help. We at The Motley Fool believe that investing in the stock market is the best path to long-term wealth. But it isn't always easy to stick with stocks. Here to talk about how to manage and stomach all the risks so you can reap the rewards is Ben Carlson.

1:04Ben is the Director of Institutional Asset Management at Ritholtz Wealth Management, the writer behind the Wealth of Common Sense blog, the co-host of the Animal Spirits podcast, and the author of five books, including his latest, Risk and Reward, which will be available on May 12th. Ben, welcome to Motley Fool Money.

1:21Ben Carlson:Great. Thanks for having me. So it seems to me that one of the main goals of your book is to convince people that they should invest the stocks. But for that to work out, they have to hold on through thick and thin. And the evidence is clear. U.S. stock market always recovers from previous downturns, reaches all-time highs. But people still need the reassurance, right? Especially during the tough times. You know, sometimes even I feel like I need the reassurance, especially as I'm getting older, getting closer to retirement. So why do you think people need that constant reminder? Do you think it's mostly a rational fear or is it more one of those behavioral quirks from when we humans were hunters and gathers being chased around by lions and it doesn't make as much sense nowadays?

1:58Ben Carlson:Yeah, that's part of it. It's funny. I did the audio book for this one for my first time. So my publishers asked, hey, do you want someone else to read it or do you want to do it yourself? I said, I'll let someone else read it. Then I thought, wait a minute. I do the podcast. Now I can try this myself. I'm not like an order. I'm not really great at these things. I don't like the sound of my own voice, but I'm going to give it a try. And, you know, I've got this other person in my ear who's telling me, hey, slow down, speed up, do that word again, try this sentence again. So it was an interesting experience.

2:24Ben Carlson:And the gentleman who was working with me on the other end, he said, listen, I work for a publisher, but I'm not in the markets at all. And he said, your book is terrifying me. Everything is making me very anxious. Hearing all these bad things that can happen, this is scary stuff. He said, just listening to you talk about it is making me anxious, but I appreciate you, you know, providing you the side. And so I think this is just, it's something that I try to get this point across is that, you know, human emotions are not good or bad. They just, that's what we are. Like we can't really help it.

2:49Ben Carlson:Right. And I always say that human nature is like the one constant across all market cycles. And so it doesn't matter how experienced you are with this stuff, you're still going to get those feelings. And that's what I try to convey here is just, just point out that like these things can and will happen and you have to somehow build them in their plan. Just not, not hope them away that they won't happen at some point. Right. So I think that's the big thing is just to provide context around people and show that, yes, I still believe long-term investing in the stock market is your best builder of wealth over the long term, just like you said.

3:16Ben Carlson:But you have to get used to these bad things happening along the way, too. Yeah, but for what it's worth, I saw it as the complete opposite. I saw the book as very optimistic, very realistic about what could happen. But investing in the stock market is the way to go. And I do think that part of the reason, too, is that it's pretty easy for people to look at situations going on and saying, you know what, this time it's different, right? During the dot-com crash, we had valuations at the highest point ever, even higher than before the Great Depression. During the great financial crisis, we had the first nationwide crash in home prices, old banks like Lehman Brothers going out of business, the pandemic, the worldwide economy goes on pause.

3:51We're sanitizing our groceries before we bring them into the house. And then today we have AI, right, where we're worried about millions of people losing their jobs and businesses going out of business. And of course, I'm sure many of us have heard the classic John Templeton quote, right? The four most dangerous words in investing is this time that it's different. But it's still hard not to feel that way, especially when sometimes things are different.

4:11Ben Carlson:Yeah, it's funny. Templeton actually in an interview before he passed away said, actually 20 % of the times things really are different, right? But your whole point about me being an optimistic person, you know, I've always just been kind of a glass-staffled person, but I really, it felt like everyone's sentiment after the great financial crisis was really beaten down. And I had just started my career. I was, I don't know, five years into my career in the markets when a great financial crisis happened and seeing the aftermath of that. And I saw all these professional investors that I was working with completely, like you said, that, okay, this time really is different.

4:37Ben Carlson:What if the stock market doesn't come back and returns are awful from here? And we were living in the new normal. And that's the market that I grew up in, in the environment. And the sentiment was really beaten down. And everyone was just predicting the next nasty thing to happen, the double dip recession. And we're never going to come back. And Greece is going to take the world down. Remember the Cyprus Bank and all this stuff. And I thought, well, geez, I don't know. So the stock market just fell 60%. History tells me that's a pretty good time to buy. And I never would have expected we're going to have, hey, a 17-year bull market or something coming off of that.

5:04Ben Carlson:My point was, if you really think that this whole thing is going to go under and not going to come back, then what's the point of investing in the first place? So I've always kind of had that more optimistic long-term view. But you're right. You have to be realistic, too, and understand that the bad stuff comes with the good, and it's kind of like two steps forward, one step back when you're investing in the markets. I think another point, of course, is that we all hate to see our net worths go down. You mentioned loss aversion in the book, which is that concept from behavioral finance, which posits that, you know, losses hurt twice as more than gains feel good.

5:33But you also illustrate that you could be a pretty lousy investor and things could turn out all right. So let's turn to a Ben Carlson classic and hear the story of Bob, the world's worst market timer.

5:44Ben Carlson:Yeah, which was kind of the inspiration for the book. Again, this came out of the great financial crisis and people worried. And it was funny because in 2013, after four or five years, we finally hit new all-time highs again, right? Coming out of the great financial crisis. It was like October 2007. In 2013, we finally hit it again. And at that point, people go, okay, we've seen all-time highs before. Guess what happens? It leads to a cliff. And I wanted to see, like, okay, fine. Let's play the devil's advocate. Say you are investing right before a calamity. You invest right before the peak. So I decided to use this parable of the guy who was the world's worst market timer.

6:15Ben Carlson:And I said, what if he only bought before 50 % crash in the 1970s, the 1987 crash, and right before the dot-com bubble blew up, and right before the great financial crisis? He only bought then, and he sat in cash between then, but he held on to his shares. How would he have done? If he only bought at the peaks, he got crushed right afterwards, but he held on over the long term. And how over 40 years of investing, how did he do? And the numbers were shocking, and I didn't even know what they looked like before I ran them. And I did this back in 2014, and I tell people this. It's kind of crazy. I look at my stats for my blog every once in a while.

6:45Ben Carlson:Every year, it's still my most read post. People still read it to this day more than 10 years later. And it's funny that whole concept really resonated with people like, oh my gosh. So you can actually make mistakes, but as long as you extend your time horizon and you keep saving and you keep investing and you don't get scared out of the market. That was the whole point. Don't get scared out. You can actually still have pretty good results. And people like that. But the other one was, and again, the whole point of this book was, okay, fine. That was in the US. What about elsewhere? What if you were in Japan?

7:14Ben Carlson:What if this? And I get a lot of what ifs from people. What about this scenario? What about lost decades in this? And that was the whole point of the book is to go through all those caveats and warts and all of long-term investing and then provide some context around them. But it is funny how that one piece still resonates with people in good and bad ways, right? People want to pick it apart and people want to take it and go, okay, the long-term actually is your best friend. To put some numbers on that, in the scenario, Bob starts saving in the early 70s, retires at age 65, and despite being a horrible market timer, he retires a millionaire,$1.1 million, which is pretty amazing.

7:50On the other hand, if he had instead just been dollar cost averaging into the market over that time, he would have had more than twice that,$2.3 million. dollars.

7:58Ben Carlson:Right. Yeah. And the point of that was my big takeaway there is like, don't try to overthink this, right? And try to perfectly time when I should put money in and when I should take it out. And if you just consistently put money into the market and kind of diversify your entry points, that's what I like to say about the beauty of dollar cost averaging is not only that most people do it because when they get paid, right? They invest when they get paid. People get paid on a set schedule. They don't sit there with a lump sum of money unless you get an inheritance or something or win the lottery. Most people invest on a dollar cost average basis because that's how the world works and that's how you save over time.

8:29Ben Carlson:You save on a monthly or a weekly basis or whatever, but you diversify your entry points. So one entry point is not going to crush you if something does go wrong. And guess what? It's also like a very simple strategy that doesn't require a lot of brain power, right? It doesn't give you a lot of brain damage of trying to pick the right time. And oh gosh, what if I pick the wrong one? What if this happens? And you don't have to what if as much anymore when you just spread your bets. So the story of Bob shows that long-term investing historically worked out, and you have all kinds of great statistics in your book showing that, the risk, but also the rewards.

9:00Are there one or two facts or figures in your book that you hope really stick with people when they're done reading your book?

9:06Ben Carlson:The one that's always stuck out with me that I've used a lot is I looked at the 30-year returns for the U.S. stock market going back to the 1920s. And okay, let's say you actually picked the very worst. You're worse than Bob. You put your money in right before the worst crash in history, and you put your money in September 1929, the Great Depression, right? You put your money in there and you hold it for 30 years. How did you do? You know, reinvested dividends along the way. And the worst 30-year return that we've seen over the past 100 years in the U.S. stock market is about an 8 % return per year, which is kind of crazy.

9:38Ben Carlson:Now you had to live through an 80 % crash to get there, right? I don't know how many people actually had the wherewithal and the ability to do that. But it is kind of shocking that even at that worst point in history, you stood at like an 800 % total return. right from that point and and so I think that one is interesting to me I really liked the Roger Federer stuff it's kind of funny I put two tennis people in my book I'm not a big tennis person I never played tennis or anything growing up my dad tried to get me to play didn't really stick with me but Roger Federer said that he won like 80 % of his matches one of the greatest professional tennis players of all time but he only won 54 % of his points and those numbers line up almost exactly with the stock market right look on a daily basis the market is up something like 52 53 54 % of the time it's only a little better than a coin flip, that the stock market is up or down on a given day.

10:24Ben Carlson:But you extend your time horizon and you go out three, five years. Now we're talking about being up like 80 % of the time on an annual basis. And I thought that parallel was interesting too, that just the longer you extend your time horizon. I always say that the stock market is the best casino in the world because the longer you stay in a real casino, the worse your odds of success, right? The house always wins because the longer you stay, their odds are in their favor. And it's the total opposite in the stock market, which is always funny to me when people compare the stock market to a casino, because if it is, it's the only casino where the house doesn't win if you stay in longer.

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12:05One of the facts that I took away from the book, which is sort of related to that, is that we all know that the long-term return of the stock market is 10 % since the 1920s. But the number of years that the stock market actually returns anywhere around 10%, between 9 % and 11%, very low, like three. So one of the aspects of investing in the stock market is you don't really know what you're going to get in the short term, but the longer you hold on, your range of returns sort of narrows, which makes it easier to plan for things like retirement.

12:38Ben Carlson:Yes. Yeah. And I think the number I give that the volatility returns, like over 30 years, there's actually a wider range of results in bonds and cash than there is in stocks, which is interesting, right? You're right. It narrows and narrows and narrows the longer that you hold it for. And that other one about the average, like I always say that the average stock market returns never average in a given year. So I think that the average year in an up year for the stock market is like 21%. And the average year in the down year is down 13 or 14%. So it's a really wide range from any given year. And that's one of the things that makes the stock market so interesting and challenging is because if you could just plan, all right, I'm going to get 10 % here, 10%, it would make your life much easier.

13:17Ben Carlson:Financial planning would be easier. Your emotions would be easier. But if the stock market did that, if it was easy, you wouldn't get the risk premium, right? So the stock market has to be volatile like that to give good returns over times. And that's the thing that gets people is getting too high or too low when things are really good or really bad. You'd mentioned the Great Depression. And a lot of the data in your book does start with 1928, so it includes the Depression, which was just horrible, right? And it wasn't just one bear market. It was a series of bear markets. Overall, the market's down 86%, as you point out in the book, that after a loss like that, you have to earn 615 % just to get back to break even.

13:51And when you see other statistics about historical returns out there on social media, or even from some financial services firms, they often start at the end of World War II, or maybe 1950, which I think sort of implies that they think, eh, the Great Depression, that couldn't happen again. But you chose to include it. And you point out how bad it was. You point out that 18 of the 26 worst monthly returns of the stock market happened between 1929 and 1940. So do you include it because you think, wow, if it happened in the past, of course, we could have another Great Depression? Or do you think we're probably beyond that, but it's still important to include it because it shows that even long-term investing could survive those horrible returns?

14:29Ben Carlson:Yeah, I think it's worth including because, yeah, it's part of the long term. I think that's interesting too. Like, hey, that 86 % crash is part, the 10 % return is inclusive of that 86 % crash. But I think it's also, I don't necessarily think it could happen in the US, save for an alien invasion or something. But even if we got attacked by aliens, we're probably gonna spend on infrastructure, right? So maybe that's a boom to the economy. But it's happened in other countries, right? I think you could look at other countries around the world and have a 70, 80 % crash in the stock market. One of the other things I talk about in the book is how ownership has changed over time.

15:00Ben Carlson:That was one of the interesting things I found about the Great Depression is basically no one owned stocks back then because people couldn't really afford it. There wasn't a lot of disposable income. The number I found was like 2 % to 3 % of households even owned any stocks in the Great Depression. So it's kind of a misnomer that everyone lost their shirt and got crushed in the stock market. It was more the economy that really crushed people back then. So I think the fact that the stock market is more important these days, and we've seen that in a crisis period, the Fed and the government is willing to throw the bazooka at these problems.

15:25Ben Carlson:I guess you could say, well, maybe if they didn't do that, then all bets are off. But I think that it would be hard to have that happen again. But if you're a globally diversified investor, could it happen in another smaller country if you are exclusively in that country? That probably could happen, right? They don't maybe not have as diversified of the economy as we have or have a central bank that was willing to do this with the global reserve currency. So it's part of the history and maybe part of the reason that we don't have a Great Depression anymore is because we lived through one already, right?

15:52Ben Carlson:The reason that we had such high fiscal stimulus in 2020 with the pandemic, I think, is because we lived through 2008. So I think there is some like market knowledge that builds on itself. And then you wonder like, well, are you just transferring these one risk to other kind of risks? And that's the kind of thing I talk about in that chapter is like these normal accidents, like trying to make these complex adaptive systems safer. all it does is you move risk from one thing to another and it manifests in different ways. The phrase long term has come up a bit in our conversation and it's in the subtitle of your new book.

16:21But what does that mean for you, right? So what's the time frame for you for which, you know, someone says, I need money in this number of years and you'd say, oh, well, that should be in cash or I can leave it alone for this number of years. And OK, you're probably going to be OK in the stock market. And I'm sure there's a bit of a gray zone in between those two.

16:38Ben Carlson:Yeah, I think it's something like probably, you know, if you need that money in five years or so, it probably shouldn't be in the stock market because you can have really bad returns over a five-year period. Most of the time, the stock market is up over a five-year period. But I think if you're talking about something like a down payment for a house or something or a wedding, I think you've got to be pretty careful and at least have some sort of diversification there. And I talk about that in the book too, that, you know, having an offset to the stock market is a good idea, just so you're not selling stocks when they're down.

17:04Ben Carlson:I think that's a pretty good rule for them. Some people would say that's way too conservative. What are you talking about? I can handle that. And maybe it is. I think personally, in terms of a barbell, if you need to have that money, I don't want to be in a position to sell stocks when they're down and be a forced seller at a bad time. Because I think that's the whole thing about stocks in a bear market is if you have the ability to extend your time horizon, not just buy more in a bear market, but just let it ride and not have to sell, I think that's a big part of it. So I think long-term for me is five to seven plus years, or something like that.

17:36You've touched on international investing a little bit and mentioned Japan. I'm about, I don't know, 15 years or so older than you. So I was a teenager in the 1980s, which was just a fantastic decade for Japan, right? And so I remember all the headlines back then about how Japan was taking over the world. There was worry that US would be surpassed. American companies were being encouraged to take on Japanese business practices. Japanese companies were buying up real estate like the Rockefeller Center and companies like Firestone. But then things changed in 1989, right? The Japanese stock market plunged and it didn't get back to its previous high until relatively recently.

18:11You devote two chapters to Japan in your book. Tell us a little bit about how crazy things got and what you think the lessons for investors are when they look at what happened in Japan.

18:21Ben Carlson:You know, when I went to go title this book, I jokingly said to my publisher that I wanted to call it Nausho Japan. That would have been a little too inside baseball, I think. But that is the one thing I hear all the time from people over the years when they push back against the idea of long-term investing. Because I'm a big proponent of long-term investing. And I'd say in the book that buy and hold investing is not a perfect strategy. It's just better than all the other ones. That's kind of the way that I feel. But everyone always says, okay, fine, great. Buy and hold works, but what about Japan?