Investing and gambling appear to be similar activities on their faces. Essentially, you’re throwing money in a pot and praying that you see a return on your capital, risking your pocket change (or your life savings) for a chance at riches.
However, no matter what your Old Grandpa Ed tells you, there are several key differences between investing and gambling.
For instance, gambling typically comes with the expectation that you’re going to lose your capital – but if you win, you win big (hopefully).
However, investing has a decent chance of generating continuous returns, as long as you invest wisely and leave your money to work.
Investing and gambling are activities that weigh risks against return in an effort to see financial gains. However, while both produce a chance that you’ll lose your capital, one of them is far riskier than the other.
Investing involves purchasing ownership in an asset to reap the financial benefits. Investing often sees annual returns of 8-10% on a well-diversified portfolio, as companies have a financial interest in making sure that shareholders reap rewards. Your financial risks often decrease the longer you invest.
Gambling is when you wager that an activity will have a certain outcome. The mathematical odds in any gambling event are stacked against the gambler, which means the house or bettor stands to win the majority of the time. Their chances of winning – and your level of risk – increase with every new bet you lay down.
What is Investing?
Investing is where you buy and sell stocks and other assets with the intent of seeking financial return. These may take the form of asset appreciation, income from dividend payments, or additional stock.
Risk Versus Return
The concept of risk versus return is one of the basic tenets of investing. Usually, lower-risk investments generate lower returns, while higher-risk investments offer bigger profits – assuming you don’t lose your entire investment.
It’s important to note that risk and return fluctuate across assets and asset classes. For instance, blue-chip stocks like Microsoft will have vastly different risks than a department store like Macy’s. This variety is one of the reasons that investors tout the benefits of diversification, or spreading your capital across sectors and asset classes to minimize potential losses.
Putting Money in the Pot
Every investor has to decide how much they want – or can afford – to allocate to their portfolio. Some individuals may take a chance with their entire life’s savings. Others may stick to religiously devoting $50 a month for years.
Once you know how much you want to put in, it’s time to allocate your funds. You may consult a financial advisor or do independent market research to determine your choices. Looking at a company or fund’s market performance, underlying financial data, and their mission and leadership may all inform your decision.
To actually purchase shares, you typically go through a broker or third-party firm, such as a robo advisor, to purchase your investments. This can limit your returns, as most charge commissions or fees for their services.
What is Gambling?
Gambling, also known as betting or wagering, is where you stake capital on the outcome of a particular event. Typically, this involves taking on big risks based on chance and uncertainty.
There are several types of gambling in modern society. Some individuals like to bet on horse races, team sports, or other rivalry-based activities. Lotto tickets and scratchers can be found at many convenience stores around the country. Casinos are another popular option, as they offer entertaining games of chance such as card and dice games, as well as slot machines.
Gamblers, too, have to consider how much they can afford to lose when they play. They may assess their risks by doing background research, learning to count cards, or memorizing competitors’ cues and facial expressions.
The odds in any gambling activity are stacked against the gambler. This lends gambling an overall higher risk versus the potential rewards; in fact, gamblers are often lucky to win back what they bet, let alone see a profit. Winning that $10 billion lotto jackpot would be amazing – but chances are, you won’t win, and you’ll never see that $20 again, either.
Key Differences Between Investing and Gambling
The point of putting capital to work is to hopefully generate profits without piling on the risks. However, when you look at the difference between investing and gambling, it’s clear that one is far riskier than the other.
The Mathematical Advantage
Let’s start with the numbers.
Casinos are, by default, in business to make money for themselves. Thus, accepting a wager means entering an agreement in which the house maintains a mathematical advantage that increases with every next bet.
For instance, did you know that your chances of hitting your lucky number in roulette sits round 35 to 1? And that, by going for a second round, you decrease your odds of winning to 1 in 1,225?
While long odds don’t mean gamblers can’t win, they do mean that a gambler’s chances of seeing their capital again reduce drastically with every play.
On the other hand, your financial investments maintain a vested interest in seeing you do well. After all, your stock goes up when the companies perform well over time. Thus, while not every investment generates returns year over year, your odds of “winning” actually go up the longer you participate in the market. On average, a well-diversified investor will see up to 10% returns annually.
Another key difference is that investing allows you to limit your losses at the earliest sign of danger. For instance, you can set a stop loss, or an order to sell your investment, as soon as it drops beneath a preset price point. While you’ll still take a financial hit, you can cut your losses early and retain the bulk of your capital.
On the other hand, what you wager in gambling is what you lose in gambling. So, if you bet $10,000 on Lucky Day at the racetrack and he comes in dead last, you’re out $10,000. There is no stop loss to save you from a risky bet – no matter how great the potential reward.
The Flow of Information
We briefly touched on investigating a potential investment’s financial data and stock performance, as well as how gamblers may research their favorite sports team. However, the difference between how gambling and investing handle the flow of information is quite drastic.
With investing, all relevant financial information is legally required to be available to you. The company issuing the stock will put out a financial report once every quarter – a report which will promptly be digested by dozens of analysts offering their interpretation of the data’s context.
With gambling, however, there is no way to research which slot machine is most likely to give you the big payout (here’s a hint: probably none of them). Nor can you ask your favorite horse how their leg feels today, or your blackjack dealer if the cards are shuffled in your favor. This built-in disadvantage further highlights the risk you take putting your money in the hands of a bettor.
Time and Your Capital
The concept of time highlights another important difference between gambling and investing.
Gambling is almost always a short-term event. You play a wager on an activity, game, or outcome, and when the outcome has been realized, you either win big or accept your losses.
With investing, on the other hand, it’s not uncommon to see an individual hold an asset for years, or even decades, while the asset appreciates. In the stock market, time provides another valuable advantage to investors: compound interest, or the interest you earn on your interest.
Furthermore, those investors who buy bonds and dividend stocks may see profits from their investments both immediately and in the long-term. While the dollar amount may seem small, accumulating hundreds of stocks and reinvesting your dividends can generate larger returns over time.
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