Padraig O'Hannelly finds that investors have far more in common with gamblers than they might like to admit.
This article forms part of our Duelling Fools feature on 'Is Investing Gambling?'. Don't forget to read the opposing argument and cast your vote.
How many times have you read, on Motley Fool and elsewhere, that investing is not gambling? It's a theme that comes up regularly, but I have yet to find a convincing distinction between the two activities.
At its heart, I believe, is a desire to distance ourselves from the stereotypical image of the ne'er-do-well squandering the Child Benefit allowance on horses and slot machines, but this does a disservice to gamblers, many of whom are as skilled and disciplined as any investor.
Neither is it accurate to see ourselves as being in control of our financial destiny, unlike the feckless gambler, no matter how we might like to present our investment strategies to our stakeholders: "No darling, I'm not gambling, I'm investing."
Luck plus skill
Gambling spans a very wide range, from games of pure chance such as roulette and lottery, to games where chance plays a role along with skill, such as poker and betting on horses. I put investment in this luck-plus-skill category, because no matter how much skill you employ, your returns are still dependent to a significant extent on being lucky.
But I'm a careful investor
Perhaps the most common misconception is that if we're careless then we are gambling, but if we're careful we are investing. Nothing could be further from the truth.
Being diligent just shifts the odds in our favour (or doesn't, if you believe the markets are efficient), just as it does at the track, but the nature of the transaction is still the same – it's a gamble. Can anyone deny that even the most carefully chosen and conservative investments rely to some extent on the worst case scenario not happening, and that is out of our hands.
And I get dividends
Over the long run, investors as a group have made money, while gamblers as a group have lost, but this just means that investing has been better gamble than gambling. That's why I do it; that, and the fact that I'm a better judge of a company than I am of bloodstock.
Gambling is a zero-sum game, with one person's gain being another person's loss, and after the croupier or bookie takes his cut it becomes a negative-sum game -- that is, your expected return is negative. That is not to say that all gambles should be avoided; the skilled gambler is looking for situations where the odds are in his favour, just like the skilled investor.
And while, historically, investing has been profitable, it is not written in stone that this must always be the case. Investors are buying a future stream of dividends, or more accurately, they are paying for what they expect to be a future stream of dividends. For example, next year an 80% expectation of getting the forecasted dividend, 10% chance of a half divi, 10% chance of nothing, and so on for other years. This may or may not turn out as expected.
In a similar way, the owner of a betting slip has bought the expectation of a payout from the bookie -- let's say a 10% chance of a big payout, and 90% chance of nothing. The scale of the numbers is different, so we adjust our stakes and manage our bankrolls accordingly, but there is no inherent difference in what we are doing.
And I own and fund a business
Yes, holding shares does give you ownership of a business, and it's worth remembering that, but how many people meaningfully exercise their ownership rights?
As regards funding the business, that occurs when the company sells shares to investors, and this is a tiny percentage of share transactions – most of us buy shares on the stock exchange, in the secondary market.
Any wealth created in the business is a function of the original funds raised, management skill, and the passage of time; it has nothing to do with the act of passing the shares around amongst ourselves. (The ability to trade the shares in the market does, however, facilitate the initial fund-raising -- the shares would raise a lot less if they couldn't be sold on).
And in the same way that gambling is a zero-sum game, we trade these entitlements to future expected dividend streams (i.e. shares) in the hope of buying from someone who undervalues them and selling to someone who overvalues them. My profit depends on my being right and others being wrong. Ethically (although this is not an ethical debate) I have no problem with that, and I'm providing a service to both of them.
In the same way that the bookie or house turns a zero-sum game into a negative-sum game, in the secondary market the stockbroker and the Treasury also take their cut from our game of pass the parcel.
Just another form of gambling
Ultimately, investing is a game of skill and luck, as is poker and betting on sports. The pace and the odds are different, so we adjust our mindset and stakes accordingly.
Whether we play with the risks of artificially-created games, or trade existing business risks between ourselves in the zero-sum game of the secondary stock market, the game is essentially the same -- we do our research, we take a position, and we hope that luck is on our side.
> So is investing gambling? Vote now in our Duelling Fools poll.
