Tuesday, August 29, 2017

Is Investing The Same As Gambling?

There are plenty of myths about investing, among which is the comparison between investing and gambling. Here’s why they are nothing like each other. There are plenty of misconceptions about investing, but the most overused comparison is between investing and gambling. This is far from correct, as the comparison finds only one element (risk), and declares the two to be similar. Here’s why proper investing is not like gambling.

The Confusion Between Investing, Speculating, and Gambling
There are two main types of investors in Singapore. There are investors who put their money on an asset for the long term, such as people who buy index funds and hold on for 15 to 20 years. Then there are traders: investors who aim to buy low and sell high, to see a return as quickly as possible. There’s also a third type of “investor”, who is more properly called a speculator. These types put money on small chances, such as funding a start-up, in the hopes that they will see big rewards. Intelligent speculators are aware that they’ll lose money most of the time, but all it takes is one big payoff to make it all worthwhile. Which of these are like gambling? The one that comes closest is speculating, but even then, none of them is truly like gambling. Here’s why:

    Proper investing skews the odds toward you in ways gambling never will
    Gambling is almost always a zero-sum game
    Investing is only like gambling if you treat it as such

Proper Investing Skews the Odds Toward You in Ways Gambling Never Will
A well-understood rule of gambling is that “the house always wins”. The longer you gamble – be it at a jackpot machine or a Poker table – the more you tend to lose to the casino. The odds have been calculated to skew things in their favour. With proper investing – especially long term investing in blue chips or index funds – the opposite is true. There is a historical precedent for stock prices and property prices to rise in the long run: while it may not be true next year, it will almost certainly be true over 15 or 20 years. For example, look at Singapore’s property asset prices since 1976: While this doesn’t completely remove the possibility of a loss, it does mean the odds are skewed in your favour. In a casino, time is on the casino’s side. But when you’re a long term investor, time is on your side instead.

Gambling is Almost Always a Zero-Sum Game
When you gamble, the outcome always involves a winner and a loser. For you to win, the casino – or another player – has to lose. This isn’t always the case when it comes to investing*. Say you invest in a property that’s worth S$1.2 million. By the time you’ve paid it off  25 years later, its value has appreciated to S$1.7 million. The extra S$500,000 isn’t a “loss” to other property investors – you haven’t taken it from them, it’s grown as a result of the overall economy/property market becoming more developed. The same goes for assets like stocks, which grow in value as the company develops. When you gamble however, the winner’s gains always come from the loser. For the casino to win, you have to lose, and vice versa. The problem with zero-sum games is that, in the long run, one player tends to walk away with almost everything, whereas the majority of players will walk away with a loss (observe the typical Poker table, or jackpot session). *Some forms of high-risk trading, such as options trading, may be zero-sum games. But these are not typically available to lay investors.

Investing is Only Like Gambling if You Treat it as Such
There is a way for investing to become gambling, and that’s if you treat it as such. If you decide to buy and sell stocks based on “intuition”, or superstitions (e.g. the stock price matches your car’s license plate), then it indeed becomes a form of gambling. What sets investing apart is that the odds can be in your favour, if you make reasoned decisions. This means properly diversifying your assets, learning to read the fundamentals of a company before buying its stock, and being disciplined enough to follow a system.

But What About Speculating?
Speculating is not like gambling, because it is even less predictable than gambling. When you gamble, the risks are known. For example, if you are playing Blackjack, you know the main risk is going over 21, or that the dealer will have a number higher than you. As such, you can develop systems to deal with those risks: if you draw an 18, you should stand. If you draw a nine, you need to hit, and so forth. When it comes to speculating, the real world introduces so many variables that such systems are hard to develop. The start-up you invest in may turn out to be a scam, the land you bought in Nicaragua may be re-zoned as a garbage dump, and your investments in a developing country may be void as a result of a civil war. You may know some of the probable risks, but there are too many others for you to account for all of them. While expert gamblers can tell you the odds of a round, such as “10 to 1” or “47 per cent”, most speculators honestly don’t know how their investments will turn out. Their “game” is governed by fewer rules, and encompasses too many possibilities. That’s why speculating is only ever done by investors who can afford the losses. A billionaire, for example, might place two per cent of her portfolio in a company that might create the next Facebook, or might go bust in two weeks with nothing to show for it.

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