Regular readers, or those who know me have probably heard I am originally from Louisville, Kentucky. I’m not shy when it comes to talking about my hometown. When you’re born and raised in Louisville, you’re indoctrinated into the tradition of The Kentucky Derby from a young age. Some of my fondest memories are from trips out to Churchill Downs on a random weekend day, or for special occasions like Thanksgiving. The Derby in Louisville is more than the greatest two minutes in sports, it’s a two-week festival leading up to the first Saturday in May.
I was back home for Derby this year, but I didn’t make it to the track on Derby Day, opting to help my mom host a Derby breakfast, and watch from home instead. However, I was out at the track for Thurby, the Thursday of Derby week now known as the “Locals Day” at the racetrack. I couldn’t help but notice several similarities between a day at the races and investing in the stock markets. Here a few of the connections I made:
Inflation
Inflation was up 8.26% year over year as of April 30th, 2022. That is slightly lower than the end of March when it came in at 8.54%. Despite the slight decline in pace, inflation is very much on everyone’s mind these days. I can attest that it’s alive and well at Churchill Downs too. When I went to my first Derby back in 2004, a mint-julep cost something like $6. This year, the signature cocktail was up to $17! Fortunately, the minimum bet of $2 to win, place, or show, has held steady all these years!
Odds and The Wisdom of Crowds
If you’re a client of TAAG, you know we trust the wisdom of crowds when it comes to investing in the market. We don’t believe in market timing or stock picking to try to outwit everyone else that is playing the game. Rather, we trust the market to price securities fairly and efficiently. We invest to participate in market returns, not to try to outperform the market. Horseracing works in a similar fashion – the daily program contains all the information on a particular horse and race. Everything from breeding pedigrees, past performances, recent workout times, track conditions and the jockeys’ weight is public knowledge. The market participants, or bettors in this case, process this information and place their bets. The odds shift according to how much money is on each horse and in each betting pool. The money is split fewer ways if a horse with higher odds wins, so payouts are higher for the perceived increase in risk of backing a “longshot” horse. The favorite has a lower expected return, because of the better chances it crosses the line first. The odds on the tote board are not all that different from the ticker tape at the stock exchange – data is interpreted at a rapid pace, and the market determines the price.
Investing / Betting Strategies
Like stock picking, there are a million different ways to try to pick a winning horse. There are those that live and die by the speed figures. This reminds me of an investor pouring over stock charts performing various types of technical analysis looking for trends. Some look to past performance as an indicator of future results. Others still might pick a name they like, or a lucky number, akin to investing in a stock ticker that matches your initials or makes your favorite product. There are value investors who look for a variance between their price or perceived odds vs. the market price. Others trust their favorite active manager in the form of a jockey, or trainer who they think will consistently outperform. The strongest correlation horse racing and investing share is there is no repeatable way to pick winners over the long term. And if there was – no one would be sharing it!
Active vs. Passive Strategies
All of the above amount to some active strategy. Looking for some way to pick a winner against all the others and do it again and again. While the stock market has a cost to play in the form of management fees, expense ratios and transaction costs, the overall return of the market will outweigh that cost over time. You can diversify your investments and follow a disciplined rebalancing strategy to benefit from the markets going up over time. Unfortunately for the horse bettor, there is no truly passive option – outside of including Churchill Downs and other publicly traded companies that operate racetracks in your portfolio. The track makes money, in part, by taking a cut off the top of all the money bet. They pay out the remaining money, using money from losing bets to pay off the winners. The odds are such that you’re always betting in a market with a negative expected return.
Gambling Entertainment vs. Investing
Despite the similarities it should be clear that horseracing is pure gambling. It can be a fun hobby and a great form of entertainment if enjoyed responsibly. The pageantry and tradition of Derby week make it fun enough that you don’t even have to place a bet to enjoy yourself. Investing on the other hand can provide an opportunity to take advantage of compounding returns and reach a variety of financial goals. Provided you have a plan, stick to it, and don’t turn the stock market into a year-round Derby party.
Oh, and for those wondering – I did not have a bet on the 80-1 longshot winner of the 2022 Derby, Rich Strike. I guess I’ll have to stick to my day job!