Explaining the difference between gambling and investment decisions and how they affect your risk of losing your money.
Have you ever heard the phrase “the stock market is like a casino”?
Many beginner investors confuse the difference between gambling and investing. They quickly dismiss the benefits of investing as they don’t want to risk losing their invested capital in what they perceive as a bet.
To be fair, investing can sometimes seem like gambling. The truth is that both gamblers and investors take a risk in order to achieve a profit. However, investors know how to put the odds in their favor through vigorous research and a long-term mindset. Gamblers on the other hand rely solely on their luck.
That’s why you shouldn’t dismiss the idea of starting to invest too quickly. Understanding the difference between gambling and investing is important to learn the basics of investing. Once you do, you will understand the power of investing and how it can help to build your wealth.
When you gamble you make a bet on the uncertain outcome of an event. You can only recoup your lost money if you win your bet. Contrary, investors purchase assets that they expect to increase in value. As investors cannot predict the future they have to take a calculated risk and make an educated guess based on extensive fundamental analysis. This is also called speculation.
Investors commit their capital and acquire an asset in order to achieve a profit. The profit can come either from an increase in the value of the acquired asset or from paid-out income.
Gamblers, on the other hand, bet on the uncertain outcome of a specific event. Whether they will make a profit or loss from the event purely depends on luck and chance.
Let's have a look at the key differences between gambling and investing:
Investing requires a lot of research to find investments with a high return and low risk. While it is mostly a forward-looking activity, investors also rely on historical data in order to improve their chances of picking good investments.
Information about popular investments, like stocks or bonds, is readily available. For example, when you purchase stocks you can easily look up the company's earnings, balance sheet, financial ratios, or management team.
Gamblers also try to improve their chances by looking at historical data such as the track record of their opponents and their previous moves in the current gamble. However, the information they have is much more limited and highly dependent on luck and emotions.
When you invest you purchase assets and gain ownership over them.
Investors expect to make money from your investments by selling them at a higher price than you bought them. However, some assets have the added benefit that they pay you income in the form of dividends, interest, or rent.
As a result your investment always has some underlying value. Even if this value decreases since you bought the asset you can still get back a part of your money as you will only lose the difference between the current price and your purchase price. In addition, you can recoup losses by reinvesting this money into investments with better prospects.
This is in stark contrast to gambling. When you gamble you do not acquire ownership over an asset. Once you spent your money it is gone forever. The only way to recoup your losses is by either being lucky and winning more money or by spending more money on new bets.
There is a fine line between gamblers and investors as both have to risk losing their capital in order to make a profit. However, they differ in how much risk they are willing to take and how they mitigate the risk of losing their capital.
Gamblers are known to go all-in and risk their whole capital at once. They expect to quickly increase their money as they usually bet everything on the outcome of an upcoming event. This risk will either be rewarded or they lose their whole capital.
Investors, on the other hand, know that achieving high returns requires a long-term mindset. They take smaller calculated risks by investing in well-researched assets. These assets will be held for longer durations in order to benefit from the power of compounding.
In addition, they have to further manage risk through diversification. Part of diversification is to understand how different asset classes correlate with each other so that one losing investment does not cause losses for others.
Before you start to invest you have to figure out your investment objectives, investment horizon, and risk tolerance. Your investment objective could be to fund your retirement or to save money for your child's education.
Depending on your objectives you will select investments that align with your timeframe and risk tolerance. If you plan to retire soon you will likely select stable investments which hold their value well, such as bonds or real estate. However, when you're young and retirement is far away you will likely pick investments with long-term growth prospects, such as stocks or exchange-traded funds.
Gamblers, on the other hand, rarely gamble with a long-term objective. Instead, most gamblers are betting their money for one of two reasons:
Investing is a well-accepted financial practice to grow your wealth. Everyone should invest their money in order to achieve long-term financial objectives, such as funding retirement. However, it is important that you approach investing with a long-term mindset. You should also leave your emotions out of any investment decisions you make.
Gambling is an addiction that can severely impact the lives of those who suffer from it. It can take a toll on relationships, jobs, and mental health and is classified as an impulse-control disorder. As a result, gambling is not accepted as a sound financial practice to earn money and grow wealth.
Instead, gambling is a high-risk activity where you may lose money and damage your mental health and relationships in the process.
Now that you know the differences between investing and gambling you might still be confused about how gambling applies to investing.
Investors put a lot of effort into researching investments with good growth prospects and attempt to combat risk through various measures, such as diversification. Yet, aren't they still betting on their predictions turning out to be true?
If you have this question you might be confusing speculation and gambling. While both look similar at first sight, they are two different actions used to increase wealth despite risk and uncertainty.
The distinction between them becomes clear once you check their definitions in a dictionary. Gambling is defined as follows:
“The activity of risking money on the result of something, such as a gem or horse race, hoping to make money.”
Contrary, speculation is defined like this:
“The act of buying something hoping that its value will increase and then selling at this higher price in order to make a profit.”
In other words, you are gambling when you bet everything on the uncertain outcome of an event with the possibility of losing all your money. Speculation, on the other hand, means to take calculated risks based on prior research which may or may not pay off. However, these risks will rarely end with a total loss of the investment as it can still be sold at a loss. When speculating, the expected reward is considered to be bigger than the risk.
In general, if you expect to make money quickly you are most likely gambling. It doesn't matter whether you put your money into the safest investment possible. Investing is driven by researching investments with the best risk-reward ratio, not by speculative profit expectations.
You can gamble when you put your money into investments, but you shouldn't. Investing with a long-term mindset offers most people an incredible opportunity to build wealth. However to make the best of it you should follow these rules:
Continue with the next lesson of our beginner-friendly guide “Basics Of Investing”.