Investing vs. Gambling: An Overview
How many times during a discussion about finances have you heard someone say that investing in the stock market is just like gambling at a casino? Investing and gambling certainly 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.
There is also 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.
Key Takeaways
- Investing and gambling both involve risking capital in the hopes of making a profit.
- In both gambling and investing, a key principle is to minimize risk while maximizing reward.
- Gamblers have fewer ways to mitigate losses than investors do.
- Investors have more sources of relevant information than gamblers do.
- Over time, the odds will be in your favor as an investor and not in your favor as a gambler.
Investing
Investing is the act of allocating funds or committing capital to an asset, such as a stock or bond, with the expectation of generating income or a 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. Having said that. low risk generally means low expected returns, while higher returns are usually accompanied by higher risk.
Investors must decide how much money they want to risk. Some traders typically risk anywhere between 2% and 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 vary widely within the same asset class, especially if it's a large one, as is the case with the equities class. For example, a blue-chip stock that trades on the New York Stock Exchange (NYSE) has a very different risk-return profile from a micro-cap stock trading 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.
When you gamble, you own nothing, but when you invest in a stock, you own a share of the underlying company; in fact, some companies actually reimburse you for your ownership, in the form of stock dividends.
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 carefully weigh the amount of capital they want to put into play. In some card games, pot odds are a way to assess your risk capital versus your risk versus 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, which are 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.
Special Considerations
In investing, returns can be affected by the amount of commission an investor must pay a broker to buy or sell stocks on their behalf.
But when it comes to gambling, the odds are generally 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 are kept by the house whether the bettor wins or loses. Points are comparable to the broker commission or trading fee an investor pays.
Key Differences
A key principle in investing and gambling 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 if you keep playing over time, 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 and chief investment strategist of Charles Schwab.
Mitigating Loss
Another key difference between investing and gambling. That is, 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 the 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.
Why Do People Gamble Instead of Investing?
Gambling and investing are very similar in that you're putting up capital for the potential of a loss. But people often choose to gamble because of several reasons. It may require a small amount of upfront capital as is the case with a $2 lottery ticket. Gambling also causes an adrenaline rush, especially when the results (i.e. the prize) are huge. And it doesn't require a lot of guesswork, special strategies, and research (like reading reports or analyzing charts) to gamble.
Does Gambling Always Result in a Loss?
Gambling can provide players with an exhilarating rush, especially when there's a big jackpot at stake. Most players rely on the belief that they may hit a winning streak. But, the odds are rarely in your favor. In fact, the house at a casino almost always wins, resulting in a loss almost all of the time. That's because players tend to have a lower edge when it comes to winning. If you have the power to walk away after even a slight win, then you'll be able to limit your losses.
How Do I Know if I'm Investing or Gambling?
Investing and gambling have some similarities. In both cases, you're risking a certain amount of capital in the hopes of a positive return with the potential for loss. But there are inherent differences between the two of them. Investing can result in a gain as much as it can a loss and it's usually done over the short or long term. The money you invest usually gets you ownership of an asset, such as a bond, stock, or bank account. Gambling, on the other hand, almost always results in a loss and is generally a short-lived activity.
The Bottom Line
Investing and gambling both come with risks, including the risk of loss. But there is one key difference between the two. When you invest your money, there's an equal chance that you'll either lose your money or earn a return. When you gamble, though, the odds are almost always against you. Even if you win big, there's a good chance that you'll risk it all to double your money. Keep in mind, that if you invest the money that you may spend at the casino, you'll generally get an ownership stake in an asset, such as a stock or bond.
