investing and personal finance

Investing VS. Gambling

A recent conversation resulted in a short debate on whether or not investing in equities (stocks) is akin to gambling. I’ve decided to do this post as a post mortem to collect my thoughts on the matter.

For context, I am of the view that investing in stocks is not the same as gambling. I should note that some investing is like gambling, especially when it involves excessive speculation, chance and a short-term mentality. For the purposes of this post, when I say investing, I truly mean long-term investing.

Which brings me to time frame. Gambling often involves a very short time frame. For example, you walk into a casino, place a bet and see your result almost instantly, you then go on to make another instantaneous bet. On the flip side, investing often means holding onto a stock for many years and letting the results compound. The longer you play at the casino, the more likely it is likely you will lose your money. The longer you invest in the stock market, the more likely that you will earn positive returns.

Odds. Here’s another key difference. When you walk into a casino, every game you play will have the odds stacked against you (I’m excluding poker from this conversation). The house will always win (in the long run). In the stock market, the odds are you in your favor in the long term. Over the last 5 years, the S&P500 has returned investors 116.8%. Over the past 10 years, 64.7% and since 1980, has returned over 1624%. Lets focus on the last 5 years.

It has been a volatile 5 years with the world witnessing the greatest financial crisis since the great depression. In fact if you had investing $100 in March 2007 and held onto it until March 2009 you would have been left with approximately $50.  If you did not panic and held on, because you have a long time frame, you would have been up around 35% ($135 total worth of your investment today).

Investing is not without its risks, but I think its pretty clear from the above that, the odds are in the investor’s favour, whereas , odds are not in the gamblers favour.

To get into a little bit more technical explanation, we can look at expected value. The expected value (which really is just about probabilities and payoffs) of gambling is zero or negative. The expected value of a buy and hold investor (say an index fund) is positive. Of course there is noise in the short term, the gambler can go on a lucky streak and the investor might invest at the height of a bubble.

Another key component is something called asset allocation and diversification. The investor has the opportunity to spread risk across riskier and safer assets. For example a 60% stock portfolio with a 40% bond portfolio. This balanced allocation is expected to return roughly 7% over a long period of time (say over 10 years). The gambler can attempt to pay different casino games but really has no hope in achieving diversification or a positive outcome for that matter.

Finally, ownership of stocks or equities in a business actually legally represents something tangible. It represents ownership of the company. It might be small for the average investor, definitely less than 1%, but nevertheless it represents ownership and gives the owner the right to vote on proxy items and gives the holder rights to certain assets in the event of  bankruptcy. What casino game gives you anything resembling the fore mentioned?

In short, just remember a gambler puts up money in the hopes of a payoff if a random event occurs.Investing in a business (stocks) is allocating resources for a satisfactory return based on economic, financial and business principles.

 

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