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Investing, Speculating, Gambling – What’s The Difference?

People often say that investing in the stock market is gambling, but those same people probably believe that when they’re gambling, they’re actually doing some sort of investing. It’s true – you can gamble, speculate, or invest in the stock market. When you go to a casino, however, you can only gamble. At a casino, the odds are against you. If you “invest” with no appreciation or understanding of what you’re investing in, then you’re probably gambling; at best, you’re speculating.

The differences between investing, speculating, and gambling can be easily understood if you know their probability definitions. When you invest (in every sense of the word), the odds are in your favor. Sure, things could go wrong in the interim, but if you invested for the rest of your life – you would find that you make money and not lose it. The stock market has returned about 9% every year on average since its inception. Based on this, it seems odd that people are losing money. It has to do with those ups and downs or deviations and people selling in panic; buying in mania; and not knowing what they’re investing in. There’s no denying the market’s returns over time. It’s people getting caught up in periods of bull and bear markets, and mistaking speculating and gambling for investing that decreases their returns or leads to losses over time.

Gambling and speculating are not the same thing as investing.

Speculating, on the other hand, is a 50/50 situation. This would be like you betting with your friend if a coin was going to come up heads or tails. You get $1 if you win; you pay $1 if you lose. If you played this game a couple of times every day for the rest of your life, you would essentially break even. Sure, the coin might come up heads 10 times in a row, but it doesn’t change the probability of the next flip. The coin could similarly come up tails 10 times in a row on the next 10 flips. The coin doesn’t know that it came up heads or tails 10 times in a row. (Believing that the coin is more likely to come up tails if it comes up heads a lot is the gambler’s fallacy.) When you add everything up at the end of all those games, you would essentially make or lose little money. Maybe you’re plus or minus $10, but you would have speculated with thousands of dollars over that time frame for essentially zero return, a reflection of the 50/50 odds with each bet. The stock market parallel would be betting which direction the market was going to go on any given day. No one really knows. Avoid people that tell you they do.

Gambling is when the odds are not in your favor. This is when you go to the casino and play games when the probability of you winning is less than 50%. Turning back to the stock market, you would be gambling when you overpay for a stock. If you underpay, you’re investing. This is a simple generalization as valuation and other factors are needed to classify buying an asset as an “investment.” But not doing any homework – you’re likely gambling. You’re most likely gambling when you buy stocks or other assets because other people are or the market is hot. If you’re betting which direction the market is going to go today – you’re speculating.

It’s important to remember that the investing, speculating, or gambling choice is made up-front. Buy a stock without knowing its valuation or because other people are – you’re not investing. Investing involves research, mathematics, and understanding. Benjamin Graham defined investing as “capital preservation with the chance of appreciation.” Thus, if you have little or no assurance that the money you put on the line is going to come back to you – you’re definitely not investing. Real investors make money or at their worst break even. The odds are in their favor. Find situations in which the odds are in your favor, and then you can proudly call yourself an investor.

- Andrew Sebastian

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