The Thin Line between Gambling and Investing
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.
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
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 a 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 jackpot 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.