Is it my thinking that is irrational, or is it the stock market?

Fun behavioral finance exercise. I give you choice of 2 investment opportunities.

You give me $10,000 and I give you..

1. $600 back every year, but 1 in 2 chance I lose half of your $10k in the 3-5 years. Tough luck.

2. $350 every year without risk, and you can take your $10k back any time.

Which do you choose? (we'll come back to this)

The stock market is at an all time high, but so is FOMO. If you're a rationally sane person, and your view is something like: "the market COULD go up a lot more.. but it's already very high, so we might be coming up on a recession, and definitely slowing growth."

You're savvy, far above average, and take a holistic view. You don't watch the stock tickers daily and over-react to headlines. You wait for something significant, like a geo political event.

Meanwhile you're stuffing S&P and AMZN. You have some bonds (80/20?), but you're concentrated into the market a lot more than you want to admit. The strategy is simple. When there are signs of trouble, before a crash occurs, sell off some portion, move into bonds and wait for the recession to pass.

Herein lies the problem. This is literally what every single investor in the market is thinking, from the quants to the retail. They are also rational, savvy, and have a strategy. You're not actually above average. You're average (by the very definition of the word). What's worse is the system is rigged with self activating booby traps - shorts. Now clearly, not *everyone* can sell off at first signs of trouble before the crash occurs. They are one and the same thing.

It's a little bit like going to a crowded underground dance club with only one exit door, everyone knows they are having some electrical problems and a fire might break out. But you're smart - at the first signs of smoke you're going for the exit door. Before the rush occurs. I hope it's self evident how flawed this night club strategy is. Yet we view the markets differently.

You see, the idea of "first signs of trouble. before the crash" and "the crash" are actually the same thing. In fact, using the law of averages, you'll be one of the last out that door.

Now if we mentally generate a probability distribution of 3 scenarios:

1. Market continues to rally like crazy, 15%-30% YoY

2. Market grows slowly, 6% per year tops

3. Market experiences a reset in next X years

Any rational, sane person would say (1) is least probable. That leaves (2) and (3). Which means if you're heavily invested in the market, you're investing in a measly, low 6% return vehicle (bonds are 3.5%!), with a HUGE risk of not just volatility but perhaps permanent loss. Notice this is the same scenario as in the opening exercise (see top of this article).

Is it my thinking that is irrational, or is it the market?

At what probability of (3) would you no longer take a concentrated position (2)?

These are crazy times my friends. The more things change, the more they stay the same.