Is There A Difference Between Investing And Gambling?

by KNS Financial on February 4, 2011

Is investing in stocks nothing more than just gambling? Are people who toss their money into the stock market no better off than those who take frequent trips down to Las Vegas in order to “strike it rich”?

Have those who seem to know how to invest successfully, just had a string of “good luck”?  The answers to these questions have huge consequences for us.

Many people are content with just putting their money in a savings account, or at most a money market account; all because they are afraid of “gambling” in the stock market!

However, if their fears and concerns are accurate, then a lot of people who are banking on having a small fortune waiting for them at retirement will be in for a rude awakening!

Investing In Stocks As Gambling

They Both Involve Risk

Investing in Stocks and Gambling

The major connection between investing and gambling is the concept of risk. Now, without going too deep into the definition of risk, we’ll just define it as the “degree of probability of suffering a loss”. So, the thing that makes an investment equivalent to a gamble is the fact that there is a probability of loss in both!

The Big Firms Get The Breaks

Not only is there the probability of loss, but many times it seems as if the odds of success are in the favor of the major players! In the same way that the large casinos fix the games to ensure that they take in much more than they pay out, it seems as though the large Investment Banks and other Wall Street firms are the ones who make all the gains in the stock market.

This can cause a potential investor to give up and proclaim that investing is nothing more than just legalized gambling!

Investing In Stocks As A Legitimate Means To Financial Security

Financial Risk Can’t Be Avoided

While there is an element of risk when you invest in stocks, that alone is not enough to equate it with gambling. Even if you only put your money in savings accounts, CDs, money market funds, and government bonds, you are still putting your money at risk.

The only difference is the cause of your money loss – a bank, the FDIC, or failing government verses your investment not panning out. Even having your money under your mattress isn’t risk free, since you now have to worry about theft and inflation!

Knowledge Evens The Playing Field

Unlike most forms of gambling, you can reduce the probability of losing money  in an investment based on your level of knowledge and preparedness. There are tons of free research tools available online, that you can use in order to assist you in making the wisest choice for your money. In fact, those that make contrarian thinking a habit, usually make the best investors!

The Point of Investing

To liken investing in stocks to gambling is to ignore the primary reason for the stock market (from an investor’s point of view): To participate in and benefit from the growth and earnings of a particular company, through purchasing shares of ownership. Because of this fact, you face two major risks when investing in stocks – risk that your evaluation of the company was wrong; and risk that, although your evaluation was correct, the market didn’t agree.

Basically, what the first risk means is that when you assign a value to a company after all or your research and due diligence, you can still be wrong. The second risk tells us that even if you are right, the market (because in the short term, the market can be extremely irrational) didn’t realize the value in the company.

Usually, the second risk can be fought off with time since most long term investors seek out companies that have a track record of being profitable. This type of long term thinking is why you should take a look at the IRA contribution limits, 401k contribution limits, and start your retirement planning today!

Final Thoughts

I have found that most people who make this assumption do it either out of fear or ignorance. Some are fearful of investing because it seems so complicated, so they assume that no one can understand it and so everyone must be gambling!

Others just don’t understand the mechanics of investing, or how much information is available to the common investor.

Don’t be either one of those people. You can do a lot to mitigate risk, simply by learning a few basic principles of investing.

photo by Zdenko Zivkovic

Reader Questions:

  1. Have you ever told yourself that investing is the same a gambling?
  2. How do you ensure that your investments have a better chance than playing a game of roulette?

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{ 4 comments… read them below or add one }

Robert @ The College Investor February 4, 2011 at 5:00 pm

I agree with you! I don’t think that investing is gambling, but speculating on stocks/investments can definitely be gambling! If you do your homework on a stock, it is not very different from investing in a local franchise. However, if you don’t do your homework, or don’t want to, stick to index funds and don’t gamble away your money!

Anonymous February 5, 2011 at 3:19 pm

I think that many people just lump speculating and investing into the same category – which we both know is wrong! That’s a good analogy with buying a local franchise.

Kevin@OutOfYourRut February 5, 2011 at 9:45 pm

OK Khaleef, you and I are friends (and hail from the same neck of the woods), but I don’t totally agree, at least not within the context that most people play the stock market.

To begin with, any investment that doesn’t offer a guaranteed return of principal–let alone an income return of any sort–categorically is a gamble. Or at least speculating–and that’s not investing either. The hesitation that many people feel before commiting funds attests to this.

But let’s get past value fluctuations for a moment…whether or not stocks are a gamble also depends on how the market is played by the investor. There’s a difference between buying a cash flow (true investing, ie, dividends, history of profitability, etc) and gambling (buying mainly on the hope of still higher prices in the future, aka, the “greater fool theory”). Too many people fall into the latter category, especially during times when the market is in a long term bull run. That’s pure gambling.

Another issue is allocation. In my career life, I’ve had a chance to see how and where people invest their money, and what stands out most in my mind is how so many people have 80, 90, 100% of their money in stocks, usually at or near market peaks.

Maybe that’s more an attempt to commit financial suicide than gambling, but it is certifiably a gamblers mindset (I’m on a roll, I can’t lose, etc).

I agree with what you’re saying about stacking the deck in our favor, but that doesn’t change the basics of the game. In the end, we’re all human, and the human factor kicks in. Fear, greed, over confidence, buying high, selling low. At that point, yes, it’s gambling.

Maybe it would be better to call putting money in the stock market “intelligent speculation”. That’s kind of a mid-point between investing and gambling, but it’s probably closer to the truth.

Anonymous February 10, 2011 at 3:29 pm

It looks like we actually see things the same here. I think the difference comes from the fact that when I talk about investing, I am actually referring to “real” investing – meaning that I have already taken speculators out of the equation. So, I’m probably looking at a small minority of people who have money in the stock market…because most people are speculating, either because of ignorance or a desire to get rich quick.

I think that people who invest are ultimately looking for companies that will increase cash flow over time, while speculators are just “hoping” for a greater fool to come along, as you stated.

I definitely agree with you that what we see in the market – for the most part – is nothing more than gambling. However, I do think that true investing is much more than that.

Thanks for the great comment!

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