Going All-In: Investing vs. Gambling

Investing vs. Gambling: An Overview

How many times during a discussion about finances have you heard someone say, “Investing in the stock market is just like gambling at a casino”? True, investing and gambling both involve risk and choice—specifically, the risk of capital with hopes of future profit. But gambling is typically a short-lived activity, while equities investing can last a lifetime. Also, there is a negative expected return to gamblers, on average and over the long run. On the other hand, investing in the stock market typically carries with it a positive expected return on average over the long run.

Investing

Investing is the act of allocating funds or committing capital to an asset, like stocks, with the expectation of generating an income or profit. The expectation of a return in the form of income or price appreciation is the core premise of investing. Risk and return go hand-in-hand in investing; low risk generally means low expected returns, while higher returns are usually accompanied by higher risk.

Investors must always decide how much money they want to risk. Some traders typically risk 2-5% of their capital base on any particular trade. Longer-term investors constantly hear the virtues of diversification across different asset classes. However, risk and return expectations can vary widely within the same asset class, especially if it’s a large one, as the equities class is. For example, a blue-chip stock that trades on the New York Stock Exchange will have a very different risk-return profile from a micro-cap stock that trades on a small exchange.

This, in essence, is an investment risk management strategy: Spreading your capital across different assets, or different types of assets within the same class, will likely help minimize potential losses.

In order to enhance their holdings’ performance, some investors study trading patterns by interpreting stock charts. Stock market technicians try to leverage the charts to glean where the stock is going in the future. This area of study dedicated to analyzing charts is commonly referred to as technical analysis.

Investment returns can be affected by the amount of commission an investor must pay a broker to buy or sell stocks on their behalf.

Gambling

Gambling is defined as staking something on a contingency. Also known as betting or wagering, it means risking money on an event that has an uncertain outcome and heavily involves chance.

Like investors, gamblers must also carefully weigh the amount of capital they want to put “in play.” In some card games, pot odds are a way of assessing your risk capital versus your risk-reward: the amount of money to call a bet compared to what is already in the pot. If the odds are favorable, the player is more likely to “call” the bet.

Most professional gamblers are quite proficient at risk management. They research player or team history, or a horse’s bloodlines and track record. Seeking an edge, card players typically look for cues from the other players at the table; great poker players can remember what their opponents wagered 20 hands back. They also study the mannerisms and betting patterns of their opponents with the hope of gaining useful information.

In casino gambling, the bettor is playing against “the house.” In sports gambling, and in lotteries—two of the most common “gambling” activities in which the average person engages—bettors are in a sense betting against each other because the number of players helps determine the odds. In horse racing, for example, placing a bet is actually a wager against other bettors: The odds on each horse are determined by the amount of money bet on that horse, and constantly change up until the race actually starts.

Generally, the odds are stacked against gamblers: The probability of losing an investment is usually higher than the probability of winning more than the investment. A gambler’s chances of making a profit can also be reduced if they have to put up an additional amount of money beyond their bet, referred to as “points,” which is kept by the house whether the bettor wins or loses. Points are comparable to the broker commission or trading fee an investor pays.

Investing vs. Gambling: Key Differences

In both gambling and investing, a key principle is to minimize risk while maximizing profits. But when it comes to gambling, the house always has an edge—a mathematical advantage over the player that increases the longer they play.

In contrast, the stock market constantly appreciates over the long term. This doesn’t mean that a gambler will never hit the jackpot, and it also doesn’t mean that a stock investor will always enjoy a positive return. It is simply that over time, if you keep playing, the odds will be in your favor as an investor and not in your favor as a gambler.

“Neither get in nor get out is an investing strategy. Period. That’s just gambling on moments in time. And investing should always be a disciplined process over time,” said Liz Ann Sonders, managing director & chief investment strategist of Charles Schwab.

Mitigating Loss

Another key difference between investing and gambling: You have few ways to limit your losses. If you pony up $10 a week for the NFL office pool and you don’t win, you’re out all of your capital. When betting on any pure gambling activity, there are no loss-mitigation strategies. Newer innovations to online sportsbooks have been added to help gamblers mitigate risks when betting on games such as in-play bettering, which can be changed throughout gameplay, and partial cash-out options, which allow recovery of part of one’s wager if an outcome seems to be going against the best.

In contrast, stock investors and traders have a variety of options to prevent total loss of risked capital. Setting stop losses on your stock investment is a simple way to avoid undue risk. If your stock drops 10% below its purchase price, you have the opportunity to sell that stock to someone else and still retain 90% of your risk capital. However, if you bet $100 that the Jacksonville Jaguars will win the Super Bowl this year, you cannot get part of your money back if they just make it to the Super Bowl. And even if they did win the Super Bowl, don’t forget about that point spread: If the team does not win by more points than given by the bettor, the bet is a loss.

The Time Factor

Another key difference between the two activities has to do with the concept of time. Gambling is a time-bound event, while an investment in a company can last several years. With gambling, once the game or race or hand is over, your opportunity to profit from your wager has come and gone. You either have won or lost your capital.

Stock investing, on the other hand, can be time-rewarding. Investors who purchase shares in companies that pay dividends are actually rewarded for their risked dollars. Companies pay you money regardless of what happens to your risk capital, as long as you hold onto their stock. Savvy investors realize that returns from dividends are a key component to making money in stocks over the long term.

Getting Information

Both stock investors and gamblers look to the past, studying historical performance and current behavior to improve their chances of making a winning move. Information is a valuable commodity in the world of gambling as well as stock investing. But there’s a difference in the availability of information.

Stock and company information is readily available for public use. Company earnings, financial ratios, and management teams can be researched and studied, either directly or via research analyst reports, before committing capital. Stock traders who make hundreds of transactions a day can use the day’s activities to help with future decisions.

In contrast, if you sit down at a blackjack table in Las Vegas, you have no information about what happened an hour, a day, or a week ago at that particular table. You may hear that the table is either hot or cold, but that information is not quantifiable.

View Article Origin Here