Investing in the Market vs. a Gambling Parlour
“Wall Street makes money, one way or another, catching the crumbs that fall off the table of capitalism,” Buffett said. “They don’t make money unless people do things, and they get a piece of them. They make a lot more money when people are gambling than when they are investing.”
Investing and gambling has been closely associated but we want to put the case to rest and share the differences between investing and gambling.
Investing and gambling both involve risk and choice — the risk of capital with hopes of future profit. Let’s use listed Equities as a proxy here. Gambling is typically a short-lived activity, while equities investing can run a lifetime. There is a negative expected return to gamblers, on average and over the long run, while investing in the stock market typically carries a positive expected return on average over the long run.
Investing is the process and act of putting funds to an asset, like stocks, with the expectation of generating an income or profit either through dividends, interest income, or capital gains. Returns through income from the company dividends (or interest income from a bond issuer) or price appreciation of an asset are core to investing.
The process of investing is also wholly different from gambling, which often involves on-the-spot emotional decisions. In simple terms, professional investing involves countless of hours analysing the health of the company, industry and economy, and therefore the potential appreciation in value and price of the company.
Risk Investors must always decide how much money they want to risk. Is it 5%? Is it 10%? Is it 30%? Generally in each investment, there is specific risk or portfolio risk.
Specific risk refers to risk based on selecting a single asset such as a company or a bond. While portfolio risk refers to risk based on selecting an asset class or sector. In essence, portfolio risk management strategy is spreading your money across different assets, or different types of assets within the same class, will likely help minimise potential losses. Portfolio risk and diversification often goes hand in hand so that investors are able to quantify and test the risk to their investment portfolios.
Uncertainty When we invest in an asset, we are expecting a future profit. The expectation of future profits is typically uncertain, and uncertainty is the chance of something happening or not happening. Uncertainty is different from risk. Risk focuses on the chance of loss and gain, while uncertainty focuses on the probability of losing or gaining something.
In investing, investors spend countless hours trying to assess the chance of being able to make future profits. Investors assess the chance of a company making income to pay out as dividends for shareholders or make interest payments for bondholders.
Gambling is defined as betting something based on chance. Betting 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 capital versus your future profits. Pot odds is the amount of money to call a bet compared to what is already in the pot. If the pot odds are favourable, the player is more likely to "call" the bet.
In casino gambling, the bettor is playing against "the house" or “the dealer”. 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 help 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.
Investing vs. Gambling: Key Differences
In both gambling and investing, a key principle is to minimise risk while maximising profits. But when it comes to gambling, the house or the dealer always has an edge — a probability 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 favour as an investor and not in your favour as a gambler.
Mitigating loss Another key difference between investing and gambling: You have few ways to limit your losses.
If you put $100 in black jack and you don't win, you lose all that $100. When betting on any pure gambling activity, there are no loss-mitigation strategies.
On the other hand, stock investors and traders have a variety of options to prevent total loss of its capital. If you invest in an asset that drops 10% below what you paid, you have the opportunity to sell that stock to someone else and still retain 90% of your capital. However, if you bet $100 on black jack and you lose, you cannot get part of your money back.
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 for years. With gambling, once the game or match 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 and generate profits for the capital invested. Companies pay you money regardless of what happens to your capital, as long as you hold onto their shares.
Getting Information Both stock investors and gamblers look to the past, studying historical performance and current behaviour to improve their chances of making profits. 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 putting 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, 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.
In summary, investing and gambling both involve risk and choice (and uncertainty). In both cases, investors or gamblers assess the amount that they will lose some or all money (risk) and the chance (uncertainty or certainty) that they will make or lose money.
In gambling, the risk-return reward is more towards losing the money you bet for a game, match, or hand. And often, the probability is not in your favour (the chance of you losing money is usually more than 50%).
In investing, while the risk-return rewards vary, the risk-returns are more quantifiable and are not determined when the game, match, or hand is done. The probability for long-term investors are typically positive and are rewarded by companies that pay dividends for those who wait over the long run.
Photo credits: Monica Garwood, The New York Times
The author is Co-Founder of Simpan. Julian has over 6 years of experience in Private Equity and Investments, and currently sits on the Investment Committee of Asiantrust Asset Management. Julian earned a Master’s Degree from the London School of Economics & Political Science, and a Bachelor’s Degree from the University of Exeter.