I love to read the Reformedbroker blog. Occasionally, he would post interesting quote from other money-smart people. In his recent post, he was drawn to the analogy between casino and Wall Street, originally mentioned by Jason Zweig (full interview here):

…the fact that [Wall Street] has aspects of a casino does not mean you shouldn’t play. Because Wall Street resembles a casino in a lot of ways, but there’s one important way in which it doesn’t.

In the casino the single most important principle is what casino operators call TOD, “time-on-device.”

And from the minute you walk in the door in Las Vegas or Atlantic City or wherever you happen to be casino gambling, the people who run the casino have only one objective, which is to keep you glued to whatever game you’re playing. Because if you give one pull to the slot machine you might hit the jackpot. And if you just take your money and leave, you’ve just hurt the casino a lot. But almost nobody takes one pull, hits the jackpot…

…and leaves.

Nobody does that. And there’s a reason why. Because maximizing the time-on-device is terrible for you and it’s great for the casino.

Wall Street works the opposite way as long as you have a long-term perspective…If you’re a long-term investor, you should maximize your time-on-device. You should buy a diversified portfolio of low-cost funds and hold them your entire lifetime.

So you’ve participated in the casino but you’re not pulling any levers. You’re just watching.

To me this idea is related to the idea of expected return. Expected return is the sum of all of possible returns weighted by their probabilities. For example, I toss a fair coin. If it lands on head, I’ll give you $1, but if it lands on tail, you’ll give me $1. Your expected return is

0.50 x $1 + 0.50 x -$1 = 0.00.

Relate this idea back to casino. Pick a game — say roulette. Assuming that the game is fair (we can debate on this later), your expected return is definitely negative. From a statistical point of view, if you have to play any game with negative expected return, you want to bet all you are willing to lose in one single game. If you win, awesome. If you lose, walk away. The worse thing you can do is to put in small bet each time and play over thousand times. Expected return being negative will ensure that you have close to zero chance of walking out with cash. That is why casinos want you to spend more time at their machines – that is maximising time-on-device.

We can also calculate expected return on indexing S&P 500 index using historical data. One can imagine having a hypothetical portfolio, where on each trading day:

  • you buy the index at the market open,
  • close your position at the market close
  • and pocket the difference.

Well, the good news is we don’t have to do all the hard work. Ken Fisher has summarised this result in his book: Markets never forget (but people do). Although, for simplicity, he only focused on whether or not it gives a positive return. On any given day, you have 53% chance of a positive return any given day. However, when you play this game long enough — like 20 years, there is no any rolling 20-year period in the entire history of S&P 500 index that gives a negative return! And that includes all 20-year periods that covered the Great Depression.

A Wealth of Common Sense has charts to demonstrate this fact here. The upshot is this: you want to maximise your time-on-device in Wall Street. That generally means proper risk management.

Lastly, I should note that these performances haven’t taken into account taxes, fees, commissions, and inflation. Out of these four costs, you can greatly minimise three, namely taxes, fees and commissions. And hence, the idea of buying low-cost index fund and hold it until you retire….