When investors become gamblers

When is investing gambling?

That’s a tough question with no easy answer. In both cases you are committing money to an uncertain outcome which you hope will result in a gain.

The house always wins

The biggest difference is the odds. In gambling, the odds always favour the house. How else would casinos profit? You may have a few lucky hands or a lucky night, but in the long run most people take home less than they came with.

With investing you don’t need a loser to produce a winner. If a stock rises in value, all investors with a long position benefit and the company benefits because it is worth more.

Over the long term most stocks go up in value. The S&P 500 Composite, a benchmark of the 500 biggest stocks listed in the U.S. has averaged an annul return of nearly 5 per cent over the past 10 years – even when you include the 2008 meltdown when the index lost half its value in a few months.

If anything in investing can be compared to the house it would be the brokerage, which always makes money on transaction fees whether it goes up our down, albeit a much smaller portion.

When skill matters

In gambling the odds of winning are basically the same from player to player. In some games of skill the odds can vary slightly but remain in favour of the house. It depends on the casino but according to wizardofodds.com the estimated take from a no-skill slot machine can be as high as 15 per cent. The house pockets more than 5 per cent on Caribbean stud poker and over than 11 per cent on craps.

Investing can be a gamble - and probably is for many investors - but investors have the power to control the risk of loss. Research tools reveal a company’s earnings and revenue growth, liabilities and price history. Investors can also gauge macro indicators such as sector demand or the strength of the overall economy.

Investors also have risk management tools. Diversifying a larger investment portfolio across several sectors can act as a hedge to maximize gains and limit losses as some sectors gain and others fall.

Once a stock is purchased investors can apply stop losses to lock in gains if the market turns sour.

Finally, shareholders literally own a piece of the company, while the gambler owns nothing. Some companies pay regular dividends based on the number of shares and not the price of the share. You get paid no matter what happens, which is more than you can say for the gambler.

Frightening similarities

The 2001 bombing of the World Trade Center and the financial meltdown of 2008 made it crystal clear just how much of a gamble investing can be. Investors who did their homework, and found the best companies in the best sectors were not spared from the broad market carnage. Many of the best companies eventually clawed their way back, but it brings home the point that market hurricanes hit everything in their path.

And then there is the human element in investing and gambling. There is a growing field of study called behavioral finance that looks at how human emotion can skew rational investment decisions.

It looks at how we can trick ourselves into believing that a stock that has gone up will always go up – luring us into letting it ride or doubling down.

It also focuses on the urge to chase losses by pouring more money into a losing investment because we have trouble admitting we were wrong.

When you consider the market is made up of billions of irrational humans – investing and gambling could be one big crapshoot.