Yahoo Finance Is it Investing, Speculation or Gambling?
Often, when reading about investing, especially as it relates to the stock market, you see a comparison to gambling. Indeed, many people are scared off the idea of investing due to the regular fearmongering putting the stock market on par with a casino.
The reality, though, is that there is a difference between investing and gambling -- and speculation is something else altogether. As you work toward using investing to reach your goals and consider different ways to grow your wealth, understanding the difference between investing, speculation and gambling is essential.
[See: 7 Easy Ways to Invest Without Much Money.]
David Stein, a former fund manager and chief investment strategist with a $70 billion advisory firm, tackles this issue in his book "Money for the Rest of Us." Here's what you can learn about the difference, and how knowing the difference can help you make better decisions.
Investing
First of all, Stein points out that investing consists of "opportunities that have a greater likelihood of being profitable."
When you invest in the stock market, there is the chance of loss. However, your chance of seeing a profit is higher.
Take indexing, for example. While there are year-to-year losses, if you look at the historical data, the S&P 500 has yet to see negative returns in any 20-year period. If you invest in an S&P 500 index for the long haul, there's a high likelihood that you'll be profitable.
Investing doesn't necessarily mean that you beat the market. But it does mean that your personal position is likely to improve over time. "For example, stocks, bonds and real estate can be classified as investments because they have positive expected returns," Stein writes.
Speculation
Speculation, on the other hand, consists of "opportunities where the investment outcome is highly uncertain," according to Stein. The key here is that your only potential for making a profit is that someone else -- in the future -- will be willing to pay more for a potential asset than you did. Stein says that, with speculation, it's almost impossible to tell whether things like comic books, cryptocurrencies or even commodity futures are overvalued because it's very difficult to determine whether someone will be willing to pay more for it later.
For some traders, speculation can work out just fine, as long as they have the stomach and instincts and "customer flow data" to help them crunch the numbers. However, Stein recommends that most people limit their speculative efforts to 10% of their portfolios.
Gambling
Gambling is something else altogether -- "opportunities that have a greater likelihood of losing money."
[See: 9 Places to Invest $500 or Less.]
Basically, an investment is something that is statistically likely to be profitable. Yes, you could lose money on an index if you panic and sell shares during a downturn, or if you invest in a company that goes bankrupt later.
However, with investing, there's a higher likelihood that you'll receive dividends at some point, or that with the right research, you'll avoid really poor choices. (Or that you'll stick with an index investment and keep pace with the market.)
With gambling, the statistical chance of losing is higher. Yes, you might win. Sure, there's a chance you could make it big. But the probability is against you. Depending on how certain binary options contracts are structured, Stein writes, those might be examples of potential gambles.
He also warns that something that might normally be considered an investment could wind up being a gamble.
"If we don't do the work to understand an investment, an asset that might have a positive expected return for most investors might actually have a negative expected return for us," Stein says. "The investment discipline of answering specific questions about an investment opportunity will help ensure we aren't gambling due to our lack of knowledge."
Stein recommends only using gambling for entertainment, rather than staking future goals and wealth on the roll of the dice -- or your ability to exit a binary option position at just the right time.
Rather than assuming that an investment in the stock market is like gambling, it's important to take a step back and look at the actual situation. Can you use analysis tools, like the price-earnings ratio, to evaluate a company and decide if it's likely to provide a profit for you? Is a rental property likely to provide you with regular income and potential appreciation down the road?
These are questions you're likely to answer with a reasonable expectation in the positive.
On the other hand, day trading or buying a piece of art might be more like speculation, since you aren't sure that someone will pay more for the asset within a set period of time.
And, finally, there are true gambles that are unlikely to pay off at all.
[See: 7 Alternative Investments That Might Fit Your Portfolio.]
Being able to distinguish between investing, speculation and gambling can help you rethink how you approach your money, and help you make more profitable decisions going forward.
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