Investing/ Markets

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With the growing popularity of prediction markets like Polymarket, many investors are wondering: Are these markets genuine investments or just another form of gambling? Prediction markets, powered by crypto, are relatively new but have quickly captured attention. The question of their true value as an investment, however, remains open.

This article explores what prediction markets offer, where they fit within the broader investment landscape, and what risks they carry. While Polymarket has emerged as a significant player, it’s important to note that it is currently unavailable to U.S. citizens due to regulatory restrictions.

What Are Prediction Markets?

Prediction markets, or betting markets, are platforms where individuals place wagers on the outcomes of real-world events—ranging from elections to sports outcomes and economic indicators. In theory, the prices on these platforms reflect the probability of various outcomes, offering what some argue is a “market-driven” consensus on future events. Polymarket, for example, allows users to place bets on issues like political races and major economic events. The platform has gained substantial traction, reportedly seeing over $3.5 billion in bets, making it one of the most popular prediction markets globally.

But are prediction markets akin to gambling, or do they serve a legitimate financial purpose? To answer this, it’s essential to evaluate their underlying structure and function.

Investment vs. Gambling: Drawing the Line

The CFA Institute defines an investment as an activity in which funds are allocated with the expectation of earning a financial return over time. Gambling, by contrast, often involves placing bets on random events with unpredictable outcomes. Prediction markets like Polymarket arguably fall somewhere in between, but definitely lean towards the gambling side of the spectrum. They operate on data, crowd sentiment, and complex algorithms, which may yield insights into certain probabilities. However, they lack the tangible, underlying assets or revenue streams that typically underpin investment vehicles like stocks or bonds or even real estate or other alternative investments.

In some cases, prediction markets can provide valuable information, but the question of whether these markets qualify as investments largely depends on the investor’s objectives and risk tolerance. For many, betting on outcomes—especially where regulatory oversight is limited—strays into speculative territory.

Matt Hougan on Polymarket and the Power of Crypto

Matt Hougan, CIO of Bitwise Asset Management and a regular guest on Intelligent Money Minute, provides a unique perspective on Polymarket’s crypto-backed structure. According to Hougan, crypto’s global reach is fundamental to Polymarket’s success, as it consolidates viewpoints from around the world, creating what he calls a “game-changer.” Unlike traditional markets, which are often limited by geography, Polymarket benefits from global interest and participation. The platform’s decentralized, crypto-native structure allows it to operate on a worldwide scale, delivering insights that are not constrained to a single market.

Another advantage Hougan highlights is liquidity. Traditional markets often rely on large institutional players to provide liquidity, but these firms have shown limited interest in prediction markets. Polymarket, however, leverages crypto-based incentives that encourage the community itself to provide liquidity, resulting in tighter spreads and greater efficiency. “A prediction market without the crowd isn’t a prediction market at all,” Hougan notes, emphasizing the importance of this approach. By incentivizing community participation, Polymarket has created a more dynamic and reliable platform.

Hougan also suggests that Polymarket is more than a one-time experiment tied to the upcoming election cycle between Trump and Harris. As global events continue to attract attention, he predicts the platform will only grow. In his view, Polymarket could become an exemplar of how crypto-backed applications go mainstream by simplifying the user experience. Many users may not even be aware that Polymarket operates on crypto, and this abstraction could be key to its widespread adoption.

For those interested, Hougan’s full insights can be found in his recent interview on our Intelligent Money Minute podcast.

The Risks of Prediction Markets

Despite the potential benefits, prediction markets like Polymarket come with substantial risks, extending beyond typical financial concerns to ethical and even national security issues.

1. Speculative Nature and Lack of Underlying Value: Prediction markets do not have any inherent asset value, and investors are essentially wagering on outcomes without tangible cash flows or revenue-generating potential. This setup exposes participants to liquidity risks and heightened price volatility, which can skew the accuracy of the probabilities on display.
2. National Security and Ethical Concerns: One of the more complex risks involves the kinds of topics open to betting. Markets that enable bets on events like the potential onset of a conflict or economic turmoil could carry national security implications. The existence of these bets might influence or exploit public opinion, adding an ethical layer to the already complex regulatory challenges. Such markets can also generate incentives that may destabilize areas of national interest.
3. Risk of Insider Trading and Manipulation: In a market that thrives on crowd-based probabilities, insider information could undermine the fairness and legitimacy of outcomes. An individual with non-public knowledge could manipulate a prediction market, undermining its credibility and potentially resulting in financial or social consequences. These platforms may unintentionally encourage insider trading and other forms of manipulation that could harm both the market and its participants.
4. Regulatory and Compliance Uncertainty: Blockchain-based platforms like Polymarket operate in an environment where regulation is still evolving, especially in prediction markets. Legal and compliance issues, such as accountability, consumer protection, and fraud prevention, remain largely undefined. This lack of clarity means that investors could find themselves exposed to unpredictable risks. Polymarket’s current inaccessibility to U.S. citizens serves as a reminder of the potential for regulatory intervention and the importance of compliance.

Are Prediction Markets an Investment Opportunity?

Prediction markets like Polymarket offer a unique insight into public sentiment on a global scale, particularly on events with high public interest, such as political elections. However, for those focused on traditional investment fundamentals, prediction markets may fall short. They lack the historical performance and financial structures typical of sound investments, with outcomes heavily dependent on human behavior and speculation.

At Intelligent Investing, we believe in a disciplined, diversified approach that focuses on long-term financial goals. Although prediction markets may offer unique insights, they are no substitute for time-tested investment principles. 

Ultimately, prediction markets may be an interesting entertainment, but they are also speculative and inherently risky. For those seeking to build wealth based on solid principles, we at Intelligent Investing advocate for a disciplined, diversified approach that prioritizes patience and a well-defined investment philosophy. While platforms like Polymarket offer glimpses into public sentiment, they do not align with the prudent, long-term strategies we believe are essential for intelligent investors. To learn more about our approach, visit investedwithyou.com/philosophy.

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Disclosure: This blog may reflect the perspectives and research of Intelligent Investing and, where applicable, incorporates insights from guest interviews or expert opinions. Any external views or opinions shared do not necessarily reflect the stance of Intelligent Investing. We may also utilize tools such as ChatGPT to enhance readability, grammar, and flow, while all core ideas remain proprietary to our firm.

Please note that Intelligent Investing does not provide specific tax or legal advice. All investments carry risks, including the potential loss of principal, and past performance is not indicative of future results. Any specific securities, sectors, or investment strategies mentioned are for informational purposes only and should not be considered a recommendation. We encourage readers to consult with Intelligent Investing for advice tailored to their unique financial situation. Unauthorized reproduction or distribution of this content is prohibited without proper credit to Intelligent Investing.

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A Time-Tested Strategy Under Scrutiny

Investing in global markets offers a wealth of opportunities, but it also requires a deeper understanding of how these markets behave over time. While much of the focus tends to be on the U.S. stock market, it’s important to consider how international markets have performed as well. A question often asked is whether the impressive long-term returns of U.S. stocks are unique or if similar results can be found globally. The data provides some insightful answers, particularly when we examine the performance of the MSCI World ex-U.S. Index compared to the S&P 500 over various time horizons.

The U.S. Stock Market: A Benchmark for Success

Historically, the U.S. stock market has been a powerhouse. Since 1926, U.S. stocks have delivered positive returns:

Time Frame	Positive Return Percentage
Daily	56%
Monthly	63%
Yearly	75%
5-Year	88%
10-Year	95%
20-Year	100%

These numbers are impressive, and they reinforce the idea that time in the market, rather than timing the market, is crucial for success. The U.S. market’s ability to generate positive returns consistently over long periods is why many investors view it as a “safe bet.” However, does this phenomenon extend to international markets?

The Global Perspective: How Do International Stocks Stack Up?

International stock data, specifically from the MSCI World ex-U.S. Index, offers valuable insights into how markets outside the U.S. have performed. While we only have data from 1970 onward, this still provides more than 50 years of market history to analyze. Here’s how the global markets compare to the U.S. in terms of positive returns over different time frames:

• Rolling Monthly Returns: The S&P 500 has outperformed.
• Rolling 12-Month Returns: Again, the S&P 500 leads.
• Rolling 5-Year Returns: The MSCI World ex-U.S. Index shows a slight edge.
• Rolling 10-Year Returns: International stocks have a higher win percentage.
• Rolling 15 and 20-Year Returns: Both markets perform similarly.

These results highlight that while the U.S. market has outperformed over shorter periods, international markets hold their own—and even surpass the U.S.—over longer time frames.

The Cyclical Nature of Global Markets

One of the key takeaways from analyzing global and U.S. stock returns is that markets are cyclical. There are periods when U.S. stocks lead the way, and other times when international markets take the spotlight. These cycles are evident when we examine rolling 5-year and 10-year returns, where the leadership alternates between U.S. and international stocks.

See this chart below and you can see that there is a cyclical nature of when the U.S. and international stocks outperform, when looking at 5-year monthly rolling returns:

The chart above shows the values of the S&P 500 Index’s returns minus the MSCI World ex USA Index’s returns. When the line is above 0, domestic stocks outperformed international stocks. When the line is below 0, international stocks outperformed domestic stocks.

US equity is represented by the S&P 500 Index; international equity is represented by the MSCI World ex USA Index. Please see below for representative index definitions. For illustrative purposes only.

For instance, there have been times when international stocks, buoyed by strong economic growth in regions like Europe and Asia, outperformed the U.S. market. However, recent history has seen U.S. stocks, driven by tech giants and a robust economy, dominate the global scene. This cyclical nature underscores the importance of diversification in an investment portfolio.

The Cyclical Case for International Exposure: Higher Expected Returns

Over the past decade, a broadly diversified U.S. stock portfolio would have returned almost twice as much as a comparable international portfolio for a U.S.-based investor. This disparity in performance may lead some investors to question their allocation to non-U.S. stocks. However, there is reason to believe that the next decade could look very different.

From April 1, 2013, through March 31, 2023, U.S. stocks outperformed their international peers by an average of 7.5 percentage points annually. This outperformance was primarily driven by rising stock valuations and higher earnings in the U.S., which contributed 3.3 and 3.2 percentage points, respectively. Valuations expanded faster in the U.S. due to higher growth expectations for the American economy and earnings. Additionally, the U.S. dollar’s strength over the past decade subtracted 2.1 percentage points from international returns, overshadowing the 1.1 percentage points of outperformance from higher dividend yields in international markets.

Looking ahead, the situation may reverse. Projections suggest that international stocks could outperform U.S. stocks by an average of 2.2 percentage points annually from March 2023 through March 2033. This expectation is based on median projections of 5.1% annual returns for U.S. stocks and 7.3% for international stocks. This potential shift underscores the cyclical nature of markets and the importance of maintaining a diversified portfolio.

Surprising Facts About International Markets

One of the most surprising findings is that international stocks actually have a higher winning percentage than U.S. stocks over 5-year and 10-year periods. This runs counter to the common perception that the U.S. market is always the best performer. The magnitude of returns, however, often overshadows these winning percentages. While the U.S. market has indeed delivered substantial gains, the consistent positive performance of international markets is a reminder that long-term investing works globally, not just in the United States.

The Importance of Patience and Diversification

Whether you’re investing in the U.S. or international markets, patience remains the ultimate equalizer. The data shows that the longer you stay invested, the higher your chances of achieving positive returns. This principle applies globally, reinforcing the value of a diversified portfolio that spans different geographies. By investing across various markets, you mitigate the risk associated with any single country’s economic downturn, while still capturing growth opportunities worldwide.

“The stock market is a device to transfer money from the ‘impatient’ to the ‘patient’.” ~Warren Buffett

Long-Term Investing Knows No Borders

The data speaks for itself: long-term investing is not a U.S.-only phenomenon. While the U.S. stock market has a storied history of success, international markets offer compelling opportunities as well. With a commitment to patience and diversification, investors can achieve positive returns whether they focus on domestic or global markets. In a world that’s increasingly interconnected, looking beyond borders is not just advisable—it’s essential for a well-rounded investment strategy.

To take the next step in understanding your portfolio’s performance and determining your risk number, we invite you to reach out for a complimentary call or coffee. We are here to assess your current portfolio and guide you through aligning it with your long-term goals. Start by visiting investedwithyou.com and clicking on the “Get Started” button. We look forward to helping you achieve greater financial confidence.

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References:

https://awealthofcommonsense.com/2023/05/the-stock-market-is-not-a-casino/

https://www.hartfordfunds.com/practice-management/client-conversations/investing-for-growth/us-and-international-markets-have-moved-in-cycles.html 

Disclosure: The information provided in this article is for educational and informational purposes only. The returns mentioned, such as the historical performance of the MSCI USA and other market indices, are based on past data and do not guarantee or predict future performance. Investing involves risks, including the potential loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. All investments should be made based on your own goals, risk tolerance, and time horizon. Please consult with a financial advisor, such as Intelligent Investing to determine the strategy that best suits your individual situation.

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A Time-Tested Strategy Under Scrutiny

The 60/40 portfolio, composed of 60% U.S. stocks (often represented by the S&P 500) and 40% U.S. fixed income (commonly represented by the Barclays U.S. Aggregate Bond Index or 5-year/10-year Treasuries), has long been a cornerstone of traditional investment strategy. This allocation has provided a balanced approach to growth and stability, blending the potential returns of equities with the steady income and lower volatility of bonds. However, recent market dynamics, especially the turbulent year of 2022, have put this strategy under pressure and raised questions about its continued viability.

Despite these challenges, a deeper analysis of historical data reveals that the 60/40 portfolio remains a robust option for long-term investors or intelligent investors. As we examine the historical performance of this allocation, it becomes clear that the win rate—defined as the probability of achieving positive returns—improves significantly over time.

First a look at just equities- The S&P 500

As you can see from above, if you held the S&P 500 for at least 12 years, you would have a 100% win rate. But most portfolios don’t consist only of the S&P 500, so let’s dig a bit deeper and add another asset class—fixed income.

The Historical Performance of the 60/40 Portfolio

One of the key strengths of the 60/40 portfolio lies in its ability to deliver consistent returns over various time horizons. By analyzing data dating back to 1926, we can observe the resilience of this allocation across different market environments. In the examples below, the 40% allocation of fixed income is using 5 year US Treasuries as a proxy.

Monthly Returns: On a month-to-month basis, the 60/40 portfolio exhibits similar win rates to the stock market (S&P 500), albeit with slightly lower volatility. This is due to the stabilizing influence of bonds, which tend to perform well during periods of economic uncertainty.

1-Year Returns: Over a one-year period, the win rates for the 60/40 portfolio slightly outperform those of a pure equity portfolio. The inclusion of fixed income provides a cushion against market downturns, resulting in more consistent positive returns.

3-Year and 5-Year Returns: As the investment horizon extends to three and five years, the win rates for the 60/40 portfolio continue to improve. The diversification benefits of holding both stocks and bonds become more apparent, reducing the likelihood of experiencing negative returns.

10-Year Returns: Perhaps most impressively, the 60/40 portfolio has never delivered a negative 10-year return in its nearly 100-year history. This track record underscores the power of diversification and long-term investing. Even during periods of significant market stress, the combination of equities and fixed income has provided a reliable path to wealth preservation and growth.

Inflation-Adjusted Returns: A Closer Look at Real Returns

While the nominal (not factoring inflation) returns of the 60/40 portfolio are impressive, it’s essential to consider the impact of inflation on purchasing power. When we adjust the historical data for inflation, the win rates do decrease slightly, but the overall trend remains positive. Even in inflation-adjusted terms, the 60/40 portfolio has delivered strong long-term returns, reinforcing its status as a dependable strategy for preserving wealth.

The Importance of Time Horizon: The data is clear—the longer your investment horizon, the higher your chances of success with a 60/40 portfolio. While short-term fluctuations are inevitable, patient investors who stay the course are rewarded with positive outcomes more often than not.

Preparing for Market Volatility

We’ve spent considerable time preparing our clients and their portfolios for periods of market volatility. By stress-testing portfolios, we provide clients with a glimpse of what their investments might look like during turbulent times. The key question now is whether to react in fear or to stick to the sound decisions that have been made.

Over the long term, equities serve as a hedge against inflation. A company’s earnings and revenues typically rise with inflation, contributing to higher stock prices. Since 1970, the MSCI USA has averaged an annualized return of 7.6%, outpacing the annualized inflation rate of around 4%. This is a testament to the power of long-term investing.

The 60/40 Portfolio as a Starting Point in Portfolio Construction

While the 60/40 portfolio has a long history of success, it is just a starting point in portfolio construction. The financial markets have evolved, and so have the strategies for building robust and diversified portfolios. There are strong arguments for enhancing the 60/40 allocation by adding other elements, such as:

• Global Diversification: Expanding the equity and bond allocation to include international and emerging markets can capture growth opportunities across the globe and provide additional risk diversification.
• Alternatives: Incorporating non-traditional assets such as managed futures, convertible bonds, and arbitrage strategies can add further diversification and reduce correlation with traditional stock and bond markets.

Private Equity and Infrastructure Funds: These investments offer access to opportunities that are often unavailable in public markets, potentially enhancing returns and providing an additional layer of diversification.

The Foundation of a Sound Investment Strategy

Before diving into portfolio construction, it’s crucial to understand your goals. Whether your objective is wealth accumulation, capital preservation, income generation, or a combination of these, your goals should guide your investment strategy. Once your goals are clear, the next step is to translate them into a well-thought-out plan. This plan then serves as the blueprint for building a diversified portfolio tailored to your unique needs.

However, even the most carefully crafted portfolio can be derailed by emotional decision-making. Headlines, market noise, and short-term volatility often tempt investors to make impulsive changes that can jeopardize long-term success. This is where Intelligent Investing comes in. We guide our clients in navigating the path to financial independence by consistently doing the right thing and avoiding the ledges of fear and greed.

Helping You Stay the Course

At Intelligent Investing, we believe that staying disciplined is key to achieving long-term success. Our approach is to help clients remain focused on their goals, avoid knee-jerk reactions to market events, and make informed decisions based on data and sound principles. By partnering with us, you gain access to expert guidance, a customized investment strategy, and the peace of mind that comes from knowing your portfolio is aligned with your goals.

We’d love to offer you a complimentary coffee or call to learn more about your financial situation and help you develop a written plan for you and your family. Visit investedwithyou.com and click on the “Get Started” button to begin your journey to becoming the next intelligent investor.

Disclosure: The information provided in this article is for educational and informational purposes only. The returns mentioned, such as the historical performance of the MSCI USA and other market indices, are based on past data and do not guarantee or predict future performance. Investing involves risks, including the potential loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. All investments should be made based on your own goals, risk tolerance, and time horizon. Please consult with a financial advisor, such as Intelligent Investing to determine the strategy that best suits your individual situation.

Schedule a short discovery call or meeting