Gambling Vs Investing

Many beginning investors often wonder about the differences, if any, between investing and gambling. Stories in the media about stock market debacles and people losing their life savings create a fearful perception towards stock investing.

Before we take a look at investing vs gambling, let's take a step back and make sure we understand what these terms mean.

Definitions

Gambling, as defined by any reputable dictionary, is the act of betting on an uncertain outcome.

Investing means committing money in order to earn a financial return.

The definitions seem to indicate a higher element of chance or randomness in gambling, while investing appears to be more rational.

What Does "Real" Investing Mean

Stock investing is usually associated with a mad frenzy of activity — stock market floors with people feverishly trading, all kinds of hand signals, lots of emotion, stress, and excitement. But that really is trading not investing.

The essence of true investing is buying into companies behind the stock and not just the stock itself. This means that you carefully research thefundamentals of the company, buy it at a good price, and hold it for a meaningful period (typically a few years, unless the reasons you bought the stock in the first place are not valid anymore.)

As you can see, there is a lot of work that goes into investing.

Buying stocks based on "hot tips", trading frequently by following the gyrations of the market, and holding on to certain stocks based on pure sentiment is not investing. It's speculation.

A Little More About Gambling

Playing games of chance like slot machines or the roulette wheel have a statistically slim probability of winning. Players put down money and hope for a win despite hopeless odds. The lure of a large gain compels people to continue this act of betting.

If gambling had higher odds of winning, casinos would be out of business.

Risk

There are card games, like poker, that demand skill. However, you cannotchoose the cards dealt out to you. In investing, you can choose your investment.

This is the pivotal difference between investing vs gambling

So how does risk play into this? Buying stock and betting on the roulette wheel both involve uncertain outcomes and therefore carry risk.

The probability of a win is a lot higher when you do your homework and buy stock. Why? With a roulette wheel, every number on the board has an equal probability of winning. So the outcome is completely random.

With stocks, when you buy companies with good fundamentals at attractive prices, the probability that they will grow and produce good returns on your investment is not random. True, there is always uncertainty in the future, but the chance of losing money in the long-term is relatively low.

As Warren Buffett once said, 

"Risk comes from not knowing what you are doing."

An Analogy

The best way to reinforce the investing vs gambling difference is to look at a simple analogy.

Let's consider the flipping of a coin. There is an equal chance (or probability) of "heads" or "tails."

But what if the coin were biased? In other words, what if the coin were weighted such that it had a much higher chance of showing us "heads"?

Now the coin flipping is no longer random. Picking "heads" greatly increases your odds of winning.

By picking stocks with the right kind of fundamental research, you are picking "heads" on our biased coin. And the wider the economic moataround the company, the higher the probability of "heads".

To wrap up, investing in stocks, when you use the right methods to pick them, is completely unlike gambling. Speculating, as opposed to investing, is more like gambling — the odds of winning are slim.

Another way of looking at the investing vs gambling question — the odds of losing your money are painfully high with gambling (and speculating).