How to Play the Stock Market, Not the Lottery

For some, Wall Street makes about as much sense as scratch-off tickets. If the risk isn't intolerable, it's baffling, and if it isn't baffling, it's likely to tempt you into high-risk behaviors. But even the experts have only recently come to understand a key truth about risk — that in the stock market, not even the big ones guarantee a big payoff.

Using a supercomputer at the University of Texas at Austin, researchers dug deep into nearly 50 years of stock market data. They were looking for the reason high-risk assets don't always deliver superstar returns, a discrepancy called the beta anomaly. Like so many quirks of finance, the reason doesn't come down to the math. It's all about the buyers.

A stock with a "high beta" is one that a buyer believes could pay big dividends down the road. It excites the same possibilities that a lottery ticket does, in other words. "Theory predicts that stocks with high betas do better in the long run than stocks with low betas," co-author and professor of finance Scott Murray said in a press release. "Doing our analysis, we find that there really isn't a difference in the performance of stocks with different betas."

When you separate your betting instincts from data about a stock, it's much more likely to follow pricing according to asset pricing theory. If you overestimate how much you'll win or lose on a stock, you're also probably overestimating the likelihood of extreme events that would cause such a return. According to Murray, "The study helps investors understand how they can avoid the pitfalls if they want to generate returns by taking more risks."

You have a lot of data at your disposal about stock histories, performances, and predictions — and unlike the lottery, that's something you can use.