How investing differs from gambling
I shudder whenever I hear someone refer to investing as gambling. Investing is certainly not gambling, at least if you’ve educated yourself before doing it. Anyone who blindly throws money into an investment is perhaps gambling, but you don’t need to do that. All you need is a better understanding of how it works and how to limit your risks.
What is gambling?
Gambling definition: playing games of chance for money.
If you’ve ever gambled on a slot machine, you give the casino your money in the hopes of a large payout. Unfortunately, every game in the casino is stacked in the favor of the house, meaning you will eventually lose money if you play long enough. None of us can win in the long run. Some people win in the short-term, but if they play long enough, they’ll lose.
I’m not going to judge people for gambling. If you do it for fun, knowing you’ll lose some money, then that’s fine. But if you’re doing it as a way to make money you’re not being very smart.
We can’t limit our risk in gambling. When I play a slot machine there’s nothing I can do to increase my chances of winning. It doesn’t matter how fast or slow I pull the lever, the house will still win eventually. In card games we can educate ourselves on the rules and practice our skills, but they are still largely a game of chance.
Gambling Fact: The house will always win in the long-term
How investing is different
Investing feels like gambling to some people. Thousands of stocks, bonds, and alternative investments being bought and sold by professionals and sometimes swindlers. But it’s actually entirely different. With investing we reduce risk and increase returns through education.
Investing Fact #1: Education reduces risk and increases returns
Let me give you an example; Investor A and Investor B work together. They both receive a bonus and talk about how they want to invest it to earn more money.
Investor A doesn’t want to gamble with his money. He heard bonds are safer than stocks and some “expert” said that bonds don’t go down in value so he purchases $10,000 of bonds. A year later bonds collapse and Investor A is beside himself. He says the markets are corrupt and he’s never going to gamble with his money again.
Investor B also doesn’t want to gamble and also heard that bonds are safe. He decides to learn how they work before investing. He learns they go up in value when interest rates fall and down in value when interest rates rise. He opens the Wall Street Journal and sees that the head of the Federal Reserve is saying he will need to raise interest rates next year. He decides this is not the time to purchase bonds. He then researches what goes up in value when interest rates rise. He learns commodities such as gold, oil, and food do, and he purchases a commodities fund that increases 25%!
When Investor B sees Investor A at work he tells him how much money he made. Investor A tells him he got lucky.
Do you know someone like investor A? He gambled instead of educating himself. Investor B minimized his risk and increased his returns through education. There aren’t haves and have nots when it comes to investing. There are just the educated and uneducated. Does that mean we will always make money if we educate ourselves? Not always. In the story above, the Fed could’ve changed their minds about raising rates, but understanding how things work drastically increases our chances of success.
Investing Fact #2: The odds are stacked in YOUR favor
There is one other distinction between gambling and investing that is hard for people to grasp: The markets and investors have always won in the long-term. Where casino games are stacked against the participant, the stock market has returned investors an average of 9% per year since it’s inception. There are years it goes way down and years it goes way up, but in the long-term the investor always wins. By simply holding a diversified basket of stocks such as an S&P index fund, the odds are stacked in YOUR favor.
Don’t be Investor A
Investor A didn’t educate himself and got mad when he lost money. He thinks investing is a game of chance but it’s not. You’ don’t need to learn everything about investing because that’s impossible. Focus on what you need. Are you in the process of choosing funds for your 401(k) or 403(b)? Then you need to learn how to choose good funds and that’s all for now. A little education can go a long way.
