Many people believe the stock market is a casino, but there are significant differences between investing and gambling.
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.
Investors commit their capital and acquire assets 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. There are many different types of assets you can invest into. A few examples are stocks, exchange traded funds, bonds, real estate, cryptocurrencies or commodities.
Investors expect to make money from their investments by selling them at a higher price than they bought them. In addition, they can make some money from income that is being paid out in the form of dividends, interest, or rent. The value of an investment is always backed by some underlying value. For example, the value of a stock is determined by the assets and liabilities of the company. Therefore, it is very unlikely, but not impossibly, for your investment to lose its total value. Instead, your loss will usually be the difference between the current price and your purchase price. You can attempt to recoup your loss by investing the money into assets with better growth 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.
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 and purchase assets that align with your time horizon 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 on their money to earn larger amounts of money quickly. Some gamblers also gamble simply for the pleasure of gambling itself.
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 their 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 the difference. After all, aren't investors still speculating on different outcomes to make a profit?
Investors put a lot of effort into researching investments with good growth prospects. In addition, they attempt to combat risk through various measures, such as diversification. Therefore, they are speculating rather than gambling.
While both gambling and speculation look similar at first sight, they are two different actions used to increase wealth while dealing with 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”.