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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

Why Gamble On Tomorrow?

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Humans have always resisted change since the beginning of time and most people will prefer things to be as they are rather than have them change.  Change is one of the surest things in this life but few of us prepare for the inevitable change that will likely happen. Nowhere is this behavior apparent than when it comes to dealing with our finances. The irony of the situation is that we wish for positive change when our finances are bad and assume things will remain the same when we are having a good time with our money.

When our financial situation is good, we gamble on the fact that it will remain the same in future with little or no contingencies in place in the event things go wrong. We would all like to be very optimistic but if you gamble on the fact that conditions today will continue into the future, then you are bound to lose.

The Ghanaian economy and for that matter most emerging market economies are going through very tough times thanks to Uncle Sam. We are currently witnessing events that were so rare in the past that we forgot about them altogether. We have started seeing job losses especially in the financial sector and this is likely to affect other sectors of the economy. People are extremely scared of losing their jobs and the situation is compounded when the individual is not prepared for such an event. There is no other time in our existence that preparing for the worst financial situation has become so important than now.

Our savings culture is nothing to write home about and the number of Ghanaians who are unbanked is very significant. We are one of worst savers in the sub-region and we lag behind the likes of Nigeria, Kenya and Cameroun. Average savings rate in Ghana is around 6.40%, meaning the average Ghanaian saves just 6.40% of his income. How can we get financial security with such a very low savings rate?

There have been a lot of talks on how we should save our money and invest in ventures that will bring us return but most of us do not pay attention to these advice because we are banking our hopes on the fact that things will remain the same in the foreseeable future.

The most important advice to anyone working is to have a contingency or emergency fund to take him or her through troubled financial times. Having the right insurance to protect you from some risk, investing for that special purchase instead of taking a loan out for it, having a moderate amount of exercise to keep fit, eating well and getting enough sleep are a few of the other important actions we can follow to be financially secured.

I am sure with the current economic environment, expected job losses in some sectors, falling rates on government treasury securities and a general level of uncertainty in the economy will at least make people pay a little attention. No one can say for a fact that we have seen the bottom of the crisis or whether there will be no more job losses. What we can all agree on is the fact that we are in very trying times and need to do something about our finances.

I gave a presentation to some members of a church in Accra on wealth creation and planning for your financial future. The questions I had to respond to and the kind of advice requested by individuals on how to prepare financially for the times ahead makes me conclude that majority of the general population are scared and very confused about how they need to prepare financially for the future. The current economic conditions come as a shock to most people because we were all under the impression that things will remain the same and there was no need to prepare for any eventualities.

Let me blast off with the idea of a contingency or emergency fund. The concept is very simple and can be the life saver when the music stops for a while. To prepare for any hitches in the employment arena. A contingency fund should have at least three months of a worker’s expense deposited in an account that can be accessed when the need arises. This will ensure that when you lose your job or have some sort of financial crisis, you will be cushioned for the next three months as you wait for the storm to clear.

A three month contingency fund is recommended for someone with a very stable employment. If your situation is different or work in an environment where employment is not secured, then you might want to shoot for fund that will take care of between six to twelve months of expenditure. If you plan on investing or have been investing for some time then you will need to get this contingency fund in place before you do anymore investment.

The reason is that you don’t want to touch your investments when you have financial problems until you have exhausted your contingency. A word of caution: contingency fund is not an investment fund and should therefore be easily accessible when the need for it arise.

Insurance penetration in Ghana is very low because we don’t appreciate the idea that there are some risks that we can easily transfer to an insurance company and pay the premium for it. I know most people have a healthy distrust of insurance companies but they provide a means to mitigate some of the risks we face. If you own a house then you will need an insurance for fire, flood and other natural disasters.

You can also take an insurance to protect the content of your house. If you happen to be the bread winner of your house then you definitely need life insurance policy to at least mitigate some of the loss that will arise with your demise. Health insurance has also become affordable over the years with an introduction of the national health insurance scheme in Ghana. If you want to survive financially then you will need to get one because things can get very bad very quickly given that we are not exercising nor eating well.

Health is very important to everyone and it is directly linked to finance and investing in a way that makes it an important consideration. Everyone is feeling the pitch currently and it will be very devastating if your health fails you when the finances become dry. Our bodies will not remain the same as we age but exercising will slow down that aging process considerably and will make you age with fewer health complications. The best investment you can do for yourself is to buy jogging shoes or a skipping rope. The diseases linked to not exercising are those that you will need to stay on medication for a long time and therefore your finances are bound to suffer.

There have been a lot of pension reforms in Ghana and the recent one calls to every worker to at least take retirement planning very serious. It has been said that the best time to start planning for your pension is the day you start working.  The new pension law makes room for the worker to contribute to their pension in addition to what is taken as social security. The new pension scheme is made up of two mandatory schemes and a voluntary scheme.

The two mandatory schemes are required by law and therefore the worker has no choice but to contribute. The one of importance to me is the voluntary scheme, which has come to be known as the 3rd Tier Scheme.  The third tier is a voluntary provident fund and personal pension scheme which provides an avenue for workers who want to contribute more to their pension to do so in a tax efficient manner. My advice is to take advantage of any avenue that allows you to invest more especially when there is a tax advantage. I am sure we have all heard of workers who retire and end up desperate because they never planned for their retirement.

Retirement also comes with all its attendant problems, health being one of the most important, which will squeeze a lot of the pension money at a retiree’s disposal. There is also the possibility that you might not even make it until retirement because of ill-health or other situations that might prevent you from working. Retirement is one of the few stages in life that when it comes and you are not prepared for it, you are SUNK!

We have always thought that things will remain as they are and have never seen job losses as we are seeing them now. Should we still gamble with the future and think things will remain as rosy as they have been in the past or rise up to the new reality that we will be traveling on uncharted waters going forward and it will take only those who have planned for the journey ahead to make it. If you still believe it is not time to take financial planning serious then I don’t think there will be anything that will trigger that kind of action until it is too late.

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