Five ways investing differs from gambling, despite what my son tells his friends
Investors have the edge with stocks, unlike gamblers at casinos, Peter Hodson writes.
I was talking to my 14-year old son the other day, and he confessed to me that he tells his friends that my job is “professional gambler.”
I was aghast, of course, and went on to explain to him that investing is dramatically different from gambling. While skill can be used in some games, gambling is heavily tied to luck. Sure, investors can get lucky sometimes but skill and homework are far more important.
I went on to explain five ways that investing is not gambling:
1)
The odds are actually in your favour
In a casino, the game with the best odds is typically Blackjack, where the house usually has an edge of one per cent or less. Craps has similar good odds, depending on the casino. But an edge is still edge: the casino will do better than you will, on average. With stocks, though, you have the edge. Stocks rise more than they fall, and over time even an average buy-and-hold investor should make money. There is a risk premium to equities, and this is your edge: Because stocks can be very volatile, you get paid to own them, through higher investment returns.
2)
Research will overpower luck
Yes, there are some gambling games that require some skill. Bluffing in poker can make you a lot of money, if you are good at it. However, most games come down to luck. Even a great poker player is not likely to win without some nice cards now and again. Many games, such as roulette, are all luck. You can study prior numbers all you want, but the odds of hitting ‘your’ numbers are still not going to change.
Not so with investing: Proper research and due diligence makes it far more likely you will have successful investments. Sure, investors can get lucky as well, but research will give you that extra edge, and provide even more investment gains. Stock selection is not — and never should be — just flipping a coin and buying a random stock.
3)
The longer you invest, the better you will do
Vegas doesn’t get all of its glitzy, fancy hotels by giving away more money than it takes in. With the odds favouring the casino, if you gamble long enough you are going to lose money. You might have some short-term winning streaks, but eventually the longer you play the more likely it is that you will end up short of cash. It is, simply, mathematics. But with the stock market, time is your absolute best friend. The longer you invest, the more likely you are to win. With markets at record highs, every single market index buyer who hasn’t sold has now made money. One can certainly never say every single tourist in Vegas has made money!
4)
Stocks are not a zero-sum game
Generally, in most forms of gambling, if you ‘win’, someone else ‘loses’, whether it is another player, or the house. Only one player gets the pot in poker (well, sometimes it is a tie), and everyone else loses all their bets in that round. The house also might take a cut. But with stocks, true shareholder value can be created. Certainly, investors can ‘lose’ when they sell a stock at a loss. But if a growing company sees its shares rise from $10 to $100, then true wealth has been created on a net basis. Despite some winners and losers along the way, the entire company is worth more than it was before. In Vegas, some will go home winners but most will go home empty-handed, which is completely different from a company generating long term shareholder value through growth and competent reinvestment of profits.
5)
Borrowing can be beneficial When gamblers get themselves into trouble, it is almost always because they have borrowed money in order to keep on gambling. Because of the above-noted points, borrowing money essentially just puts you into a big hole a lot faster. Again, you could get lucky, but more likely you just get broke. Depending on the character of the people you are borrowing money from, you might just find yourself in a lot of trouble. But, borrowing to invest is different. For one, you can deduct investment interest from your taxes (try that with your gambling loans). But really, it is the prior points and time frame that matter. Over time, your investment returns are very likely to exceed your loan costs, and you will be wealthier than you would have been without borrowing money, unlike hiding from Louis the Loan Shark which is where you will likely be with your money borrowed to gamble with.
After our discussion, my son conceded that some of my points made some sense (a big win for a dad in a discussion with a teenager). I thought I had won this conversation. But then he said, “Thanks Dad, but professional gambler still sounds way cooler, so I will probably just keep saying that when my friends ask me what your job is.”