Ask James: Gambling and the Stock Market
James, I was debating with my brother the other day about gambling. He would make the popular analogy that “life is gambling” and uses it referring to the stock market. I need some help with showing him the difference. Can you help me with that? — Danny
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There are several distinct issues in your question, Danny, so let me address each one individually.
1) Relationships and Debating
I hope you’re just having a fun kind of debate with your brother, and not the kind of debate that ends with both of you feeling badly toward each other. Remember that no matter how logical your position, neither of you is likely to concede within the context of the current discussion. People do not change their minds. Ever! But they will make different decisions based on new information. That information may simply take some time and experience to settle into the old grey matter.
2) Is life gambling?
I think the common thread he’s using to tie life, gambling and the stock market together is the word risk. Yes, all three have a degree of risk. But the real question is how to respond to the risks. Life without risks is not life at all. Investing and gambling are both risky, but in varying degrees that we need to explore further.
3) Is investing in the stock market the same as gambling?
First we need to define some parameters for our discussion:
- Let’s limit the stock market to mean the buying and selling of shares of stock in individual companies (not including mutual funds).
- Let’s define gambling as placing money in the form of a bet on a random set of circumstances occurring. Guess the outcome and win. Miss the outcome and lose.
We have to evaluate both investing in the stock market and gambling in terms of risk (opportunity for gain or loss), reward (potential return) and skill (ability to influence the outcome).
Gambling is obviously high on the risk factor, with varying odds depending on the game being played. The big lotteries like Powerball have a very low chance at winning with odds of more the 1,000,000 to 1 against you (likely much worse). Casino games like blackjack, poker and even slots have much better odds, though there are no games where the house does not have the advantage (warning sign, right?). Win the bet and you get paid. Lose and you get nothing.
The stock market also has risk. When you buy a share of stock, you get a small piece of ownership in the company. The value of a share of a company’s stock goes up or down almost every day, based on what the public believes the overall value of the company is. Buy low and sell high is the mantra to make money in the stock market.
Because you have the share of stock, you are getting something for your money rather than just a random chance (the lottery ticket or betting track stub don’t count). That share is worth something, even if it is worth less than it was when you bought it. It can eventually become worthless if the company bankrupts, so there is no guarantee of future value.
So from a risk perspective, the stock market wins over gambling, but it’s still too risky to put all of your money into one company (Enron, anyone?).
Again there is a spectrum to the rewards available from gambling. Buy a lottery ticket for a dollar, and you could win millions. Great return! However, the odds are very much against you because the old adage that you are more likely to be struck by lightning is true!
The rewards are smaller when it comes to the casinos, where penny slots may be the least risky but offer the smallest rewards. Poker or blackjack may be better odds than the lottery, but aren’t likely to make you rich (and again, the odds are always against you).
In the stock market, there’s the potential that you buy a stock just before they announce the cure for cancer or something that will see its value skyrocket overnight (anyone own Apple before the iPod came out?).
Timing is important, because it’s all theoretical until you buy or sell. Losses and gains are not realized until a transaction takes place. I had a friend who had more than a million dollars worth of stock options with MCI Worldcom. They hadn’t matured so he couldn’t sell them, and then the company went bust. Was he ever really a millionaire?
Most of the time, individual stocks will go up or down at a somewhat slow pace. The reward is not likely to be quick, and if the gains are high, brace for the losses to be just as dramatic and unexpected.
Again, give the stock market the nod on the reward side of the equation. You aren’t likely to get rich quick, but your odds of gaining over time are much better.
What is your ability to influence the outcome when gambling? Lottery? None. Casino? Depending on the game, you can learn enough to avoid some losses, but very few of the games could be called games of skill vs. games of chance. Remember that the house always has the advantage (which is why their house is bigger than yours!).
If there is no skill involved other than knowledge of the odds for or against you, and you cannot affect the outcome, stay away.
What is your ability to influence the value of a company’s stock? Very little if any at all. If you work there, you can have an impact over time. If you make a video about how they destroy guitars, you can bring the value down for a bit if enough people watch it. But on the whole, between you between you and the insider trading laws, there isn’t much chance you’re going to affect the value of a stock in a significant way.
Even the ability to pick a good stock is in question when monkeys throwing darts can perform well against the experts!
Call skill a loss for both fronts.
What is Your Intent?
An added dimension is the spirit of the transaction. “He who hastens to be rich will surely not go unpunished.” –Proverbs 28:20. Translation: don’t go for get rich quick or you will get burned.
It either doesn’t work and takes you down, or it does work and destroys your life. There are countless stories of overnight lottery millionaires who are broke and/or dead within years of winning.
Are there risks in life? You bet!
But is life a gamble? Not if you have a God who loves you! He owns the house, and the house always wins! Be a member of the family.
Here’s how I see the spectrum of investing risk/reward, with a mind toward retirement:
- Do nothing – High risk, no reward.
You need to do something to advance your future or you will have the future someone else plans for you.
Life Analogy: Stop breathing.
- Stuff cash in jar/mattress – Low risk, no reward.
With inflation considered, you’re actually losing money over the long term.
Life Analogy: Couch potato.
- CD’s/Savings Accounts – Low risk, low reward.
Few accounts keep up with inflation, but it can be a safe place to put money in the short term for specific purposes. Your retirement should not live here though.
Life Analogy: Breathing, but little life to speak of.
- Money Market Accounts – Low risk, low reward.
Better rates than CD’s or Savings Accounts, but not good enough. Okay for the emergency fund, but it is not an investment.
Life Analogy: Signs of life emerging.
- Mutual Funds – Low risk, moderate to high reward.
Investing in good, steady mutual funds may not be as fun or sexy as rolling into a casino, but you aren’t likely to lose your shirt either. The markets over the long term gain 11-12%, so this is a great place for your retirement to both grow and beat inflation. (Still, it should still be spread around…don’t put everything in one account.)
Life Analogy: Wisdom abounds…life is good.
- Stocks/Bonds – Moderate risk, moderate to high reward.
If you pick the right stocks and time things right, you can make money. But do you really have the time or knowledge to bother with it? Stick with mutual funds.
Life Analogy: Living on the edge…
- Lottery – Extremely low risk, extremely high reward.
- Lotteries are a voluntary tax on the poor and stupid. If you want to blow a dollar every once and a while (and you’re feeding your kids!), it probably won’t break you. But you’re playing the get rich quick game…and it’ll bite you eventually.
Life Analogy: Hoping for a miracle that God rarely grants…but the other guy might.
- Casinos – Gambling my hard earned money away just isn’t my thing. If you like losing money and can afford it, that’s another problem altogether. Just don’t expect to win. You won’t see me at the tables or slots anytime.
Life Analogy: Running into traffic…life is a rush if you survive.