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Investor's World

The Thin Line between Gambling and Investing

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For some gambling is a pass time but to others it’s a way of life and a means to make a fortune. It is a bit uncomfortable to note that gambling and investing even though look worlds apart have a lot in common even though they occupy opposite ends of a spectrum. Let us start by looking at a few dictionary definitions of what the two terms mean.

Dictionary.com has three definitions for gambling but the one that is very relevant to the discussion is “to stake or risk money, or anything of value on the outcome of something involving chance”.

Britannica. com has an even longer definition of gambling: Betting or staking of something of value with consciousness of risk and hope of gain, on the outcome of a game, a contest or an uncertain event whose result may be determined by chance or accident or have an unexpected result by reason of the bettor’s miscalculation”.

The words that jump at you when you read the two definitions are chance and risk and anybody who has come into contact with gambling will agree to the fact that there is a lot of risk and the whole outcome depends on chance.

Investing is a straight forward term to define, but it branches into at least three basic definition depending on the context: general, economic or financial. Investopedia.com does a wonderful job of simplifying all the three contexts. The general definition for investing is “purchase of an item or asset with the hope that it will generate income or will appreciate in the future”.

The economists insist investing is the purchase of goods that are not consumed today but used in future to create wealth. The financial definition of investing that suits the comparison between gambling and investing is to look at investing as the purchase of a monetary asset with the idea that the asset will provide income in the future or will be sold at a higher price for a profit.

Thus in simple terms, investing is for the purchase of an asset with the idea (I am tempted to say “hope”) it will provide income or be higher in value in future. There is however the uncertainty that the investment might not provide the expected income and the value of the investment might not increase or even fall in future. An example might bring the picture hope.

Let us take the example of a man working the slot machines in a casino, who is aware of the fact that he can hit the jackpot or lose all his money. The odds are not in his favor but he is still willing to take the risk.

The teenager at SafariBet betting on a Manchester United match also thinks the same way but for him there is a false confidence that he can accurately predict the outcome of the match. Contrast this picture with someone who invests in the stock market with the same misguided notion he can predict the performance of the stocks on the market.

The investor’s issue is a bit different from the SafariBet teenager because seasoned investors will tell you that the performance of the market can be predicted by assessing the fundamental strength of the companies and be able to point out which of the company’s will outperform going forward. We have all witnessed both bad market performance and extremely good ones and the market has seen companies with strong fundamentals perform poorly.

Investors, and especially investors in stocks, should be aware that there is always a chance that the stock you invest in will not behave as you expect to it. Which means that there is an inherent risk in investing and at the end of the day there is a chance the investment will not go as plan.

That is what defines gambling but in gambling the odds are stacked heavily against the gambler. I know! I can hear the argument already, that we cannot compare investing to gambling but when you look at stock market investing and the dynamics associated with it, you are led naturally to begin to look at it wearing the lens as a gambler. Let me also add that there is a term called the random walk theory that states that stock market prices change according to a random walk and therefore stock prices cannot be predicted.

There are some truths to the random walk theory even though the theory has been challenged by practitioners and academics alike. The point, however, remains that it is very difficult to beat the stock market as a whole because trying to predict the stock market is akin to the toss of coin. The idea that unites a gambler and an investor is risk.

The gambler is prepared to take very high risk with his money in the hope of making it big even when the odds of winning are very slim. A gambler bets against the house but it is a well-known fact that the house always wins.

It is easier to tell the difference between those working the slot machines, betting on the outcome of a football match or trying to hit the jack pot in a lottery and those putting their money into investment products after assessing the risk and return dynamics of the product.

It is however very difficult to differentiate between those operating in the gray area between gambling and investing. These individuals parade themselves as investors but in actual fact are gamblers.

It is a bit tricky to differentiate between the true investor and one who is behaving like a gambler. Investment literature will tell you putting all your investment eggs into one basket is gambling. Diversification plays a very important role in reducing the risk in an investment and therefore failing to diversify your investments reduces you to a gambler.

Another group in this category are individuals who take on excessive risk with the aim of making unprecedented profit. You don’t need to go far to get examples of these people. The recent microfinance crisis in Ghana gave us insights into how these gamblers behave.

What makes the situation very precarious for them is the fact that most of them are not able to independently assess the inherent risk in an investment and therefore assume these investments are safe.

If the expected returns on an investment are very high then you should expect that the investment will be riskier than one with a lower return. It is harsh to call these people gamblers, but the level of risk and the stakes transform it into a gamble.

A third group of gamblers parading as investors is those who put their money into investments without knowing or understanding what they are getting themselves into. Most gamblers have a fair idea of the odds against them even though they may not have adequate knowledge about the statistics involve. The investment sector in Ghana has a lot of such people with little or no knowledge about the investment environment.

They are the group that disrupts the performance of most markets. You cannot tell the story of gambling and investing without mentioning the speculators. Speculators are considered as investors but some but to win speculators need to gamble.

Gordon Geko in the movie Wall Street said “Speculation is the mother of all evils”. Speculators have been demonized in the past but history has showed that they are a necessary evil for the markets. Speculators were implicated in the recent significant depreciation of the Ghanaian cedi.

Speculators sometimes take on excessive risk to the point that it becomes very difficult to differentiate them from gamblers.

Gambling has been with humanity for a long time and it is huge industry that contribute a lot to some economies. Individuals gamble for various reasons and begrudging anyone who gambles will not achieve much.

There are gambling addicts, people who gamble for fun and those who undertake it as profession. The only problem is with gamblers who parade themselves as investors. To be a true investor far removed from gambling, the individual needs to reduce the level of the two elements that separate investors from gamblers: risk and chance.

As has been mentioned, gamblers take very high risk with a very high chance of losing their money. To reduce the risk of investing and increase your chances of success, the investor needs to diversify your investments to reduce risk, understand the interplay between risk and reward and have a clear knowledge about any investment undertaken. Diversification is a very easy concept to understand.

It is not a good idea to put all your eggs into one basket. The best is to put funds into investments that do not behave in like manner. Low correlated investments will ensure that a bad performing investment will be supported by a good performing one. Care must be taken when diversifying a portfolio because over-diversification will have the opposite effect of reducing returns.

It has been said time again that risk and return go together but many investors do not consider this when making investment decisions. Returns from investments do not appear out of the blue but are possible only after risks are taken.

Any investment that promises very high return is invariably taking a correspondingly high risk no matter what you are told. This point cannot be stressed more.

Let me echo the point for emphasis: risk begets return and anything else comes from the devil. The last safeguard to avoid gambling your funds away to understand any investment product you are getting yourself into. If not for anything at all it pays to have a clear idea about how the investment will make money for you otherwise your fingers will be burnt.

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Investor's World

The Menzgold Fever

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Investment scams have been with us since time immemorial and at every point in time there seems to be a scammer actively deceiving the unsuspecting general public. A lot of literature has been written on investment scams but at the end of the day investors still lose money in these so called investment schemes. I am tempted to describe the participants in these schemes as gamblers instead of investors, but I will let it pass. I am tempted not to use the word “investors” but I guess I will just let it pass until later in the piece. The reason investment scams will never go away is because we as humans cannot separate our greed from our needs.

A lot has been said and written about the Menzgold scam (yes! It is a scam: if it walks like a duck, quacks like a duck and looks like a duck then it is a …) but I would want to look at it from a purely risk-return point of view. A lot of clients of Menzgold will hate me for calling it a scam but I think we should move away from being all sensitive about it, it is a scam. Period. The company had us believe it was offering an investment product and a lot of us bought into it with our hard earned money. When the end of this Ponzi scheme comes there will be a lot of anger and people who lose money will blame everyone for the loss but themselves. The truth is, after the dust settles it will rinse and repeat and we will be back at the start when a new scheme pops up. When the DKM scam came to the fore I wrote that more of that will be brewing in future and that the same trick will be used to get a lot of unsuspecting investors.

What makes the Menzgold pitch so appealing is that the underlying investment here is gold and I don’t think it is lost on anyone how important gold is both in our traditional setting and on the global front.  As of now, no one knows the scale of the scam but from numbers that have been thrown out by the company’s clients, I think we are looking at something astronomical here.

 

The Fever

Since the Gold Fever of the eighteenth century in the United States, gold has played a very significant role in the affairs of men and was used as a store of value during the period of the gold standard. Most of the customers of Menzgold will not admit it but the mention of gold might have done it for most of them. I have heard clients say they were actually shown the gold bar that their money was buying and that they were informed it will be traded to generate returns for them. I have a question or two about this but I wouldn’t want to be distracted by the very obvious weaknesses in the scheme.

The fact that the Menzgold is a Ponzi scheme is difficult for the investors to swallow but unfortunately it checks all the boxes of a Ponzi scheme and Mr. Charles Ponzi himself will be proud of the people behind the company. What is different here is that it is gold we are talking about and because of the global market for gold it would have been very easy for the investors to verify how the price of gold was trending on the international market. Those who were making money from it will tell you there is nothing wrong with the business model and those not doing so were holding their breathe to see when it will collapse.

The government has been blamed and the regulators have had their fair share but these investors should have be guided by caveat emptor, let the buyer beware. I don’t want to hold brief for government or the regulators but I think the first group to be held responsible for the mess are the investors themselves. Claiming Menzgold clients are greedy at the point is a bit too harsh and will appear a bit insensitive given the emotional turmoil they are going through now with thought of losing their money. A case can be made for greed but let us spare these investors all the bashing and focus on what they really bought into.

 

Let the Buyer Beware

In all the talk about Menzgold, two key issues have not been dealt with in a manner that puts the blame where it really belongs. I will borrow the saving caveat emptor-let the buyer beware-to look at the issue more critically. The first issue is that nobody, especially the customers, understood the company’s business model. A company’s business model is the way it makes money and if you invest in a company without an idea about how it makes money then you don’t really care that much about your money. I have heard very ridiculous description of the company’s business model from investors of the company and it appeared none of them was really interested in how the returns will be generated to pay them their interest so far as the interest kept coming. If gold was that lucrative I think a lot of other smart entrepreneurs would have ventured into the area. The most interesting description of the company’s business model involved the buying of gold collectibles from a sister company and handing it over to Menzgold for trading to generate returns for the investor. Fortunately gold is an international commodity with price quoted by the minute and therefore any investor who wishes to check how their investments are doing can easily refer to gold prices reported by the major international media houses  or even look it up on the internet. For the company to be able to pay the kind of returns to customers, gold prices should be either volatile, trending upwards or downward at levels that have never been seen before. And we have seen a lot, especially with global crises and their impact on gold prices. If the business model of a company is complicated or lacks clarity and cannot be easily explained then you don’t have any business investing in that company.

 

It Goes Without Saying

The second issue has to do with risk and I will borrow what a journalist once said when there were issues with iphone products in the past. The journalist indicated there are two rules that govern statement it goes without saying.  The first rule is that you don’t verbalize it. In the case of Menzgold, virtually all their investors knew the interest rates offered on the investments were too high but none of them raised an issue with it. Who will raise an issue when their investment is giving them spectacular returns? According to the first rule of it goes without saying, you don’t verbalize and I must say most investors in Menzgold stayed true to the assertion. Finance and investment knowledge tells us that if the rewards offered are great then there must be something that is holding the other side of the bridge. The other side of the bridge is unfortunately the risk side and there has been very few cases in Ghana where risk has been underestimated so significantly than in the Menzgold case. This brings me to second rule of it goes without saying. The second rule is, whatever it was that went without saying, if that situation crystalizes you don’t apologize, blame anyone or try to hold anyone responsible for what had happened. Let me unpack this a bit.

Menzgold offered very high interest rates on their products and as the rule I mentioned above goes, nobody mentioned that high returns will go with high risk. When the risk for which the high returns were used as compensation manifested investors decided to break the second rule of it goes without saying by blaming everyone but themselves. The regulators were blamed together with the government but I think an understanding of the risk-return interplay would have saved a lot of these investors. If we, for the sake of argument, overlook the fact that there were regulatory lapses and Menzgold should have been brought to book way earlier than was done then we can look at the risk side of the situation. In that case I will say that the returns matched the risk inherent in the product and clients should have been concerned. Clients should have, I will be hated for this, known that there was nothing like free lunch because someone will eventually pay at the end of the day. Unfortunately they happened to be the people paying for the lunch they thought was free.

When you invest in a product that offers high return it simply means that there is high risk associated with it. If you are an investor and you do not understand this then you will always be disappointed. If a product is marketed to you as a high return low risk investment and you buy into it, then you have not been paying attention to the financial market and should therefore not be allowed to invest your own money because you are a danger to yourself.

Investments lose money sometimes but the problem arise when an investor is under the notion that they are making safe investments when in actual fact they are risking a lot. After listening to some of the investors of Menzgold I came to the realization that these are ordinary individuals with little or no financial knowledge, who decided to put all their life savings into an investment scheme they do not really understand and expected that their moneys will be safe. My Jamaican friends will say “yuh think money grow pun trees”. My humble appeal to the investors of Menzgold is, I know they will strangle me when they lay hands on me, to dust themselves off and accept the fact that they invested in a scheme that had more risk than they were made to believe. At least the experience will leave a permanent scar on them and anytime they look at those scars they will be reminded that return and risk are bedmates.

 

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