A game of Probabilities

While I used to think about investment outcome in certainty terms – is this investment going to make or lose money for me? – I have come to realize that it is more helpful to think about the range of investment outcomes in probabilistic term.

The diagram above shows the growth of a $1 investment in S&P500 starting from 1950. We can see that while the year-on-year outcome of return is variable every year, the odds over the long-term is an upward trajectory of the S&P500 index. Note this does not apply to individual stock investment, as not all stocks will recover with time. Stock market history is littered with examples of stocks that never rise to their former glorious height.

In investing, as in life, we increase our chance of success if we choose games that we can win. For long-term investment, why take the risk of individual stock investment?

By choosing to invest in an index fund instead, you get an exposure to the strongest 500 companies in the US stock exchange at any one time. Betting on the continuing upward trajectory of the index is a much safer bet than on each individual company per se.

You would have the blessing of Warren Buffett in doing so. “In my view, for most people, the best thing is to do is owning the S&P 500 index fund,” said Buffett in the May 2022 Berkshire Hathaway annual shareholders meeting.