Gambling vs Investing in the Stock Market

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When it comes to the stock market, there’s a fine line between gambling and investing. Sometimes it’s hard to tell the two apart. Both strategies attempt to make money in the market and the differences can be so subtle as to go unnoticed. When is it gambling and when is it investing? What's the difference?

Long-term vs. Short-term Focus

  • Investing is about being patient and seeking consistent returns over the long term. The focus is on buying stocks that will perform best over a period of years. The investor wants a portfolio full of such stocks, knowing that the deck is stacked in his favor over the long haul. Ups in downs either in the stock itself or in the overall market don’t change the investor’s strategy because the real payoff is spread out over many years.
  • Gambling is more of a short-term focus. It seeks immediate, high returns, but often encounters the opposite because of market fluctuations. For that reason, gambling is often more of an in-and-out trading strategy, the kind that an investor would find hard to take. Because of the high number of trades, gambling will involve paying more in the form of transaction fees, something investing seeks to avoid.

Buying Cash Flow or Price Appreciation

Investing is concerned with building cash flows. That centers the focus on dividends and companies that have a long track record of not only paying them on a consistent basis, but also of regularly raising them. As the dividend increases, the underlying stock becomes more valuable.

Not only does the stock provide a regular income, but capital appreciation on the stock as well. The investor wins on both immediate income and long-term growth. Because of the dividend, and the potential for even higher dividends later, the investor will hold onto his stock even if the price drops.

Gambling is typically a play on price appreciation. The gambler is interested in selling at a higher price, and will hold onto a stock only as long as it’s rising in price. Should the price rise come to a halt, the gambler will sell the stock and search for better prospects.

Betting on the Trend, Not the Stock

The most fundamental rule of investing is buy low, sell high. If you’re investing you’re taking that advice to heart. You’re looking to buy a stock at a time when either the stock itself or the overall market is at or near a low point. For this reason, you might prefer to be a buyer in down markets (“bottom feeder”), or to buy stocks that are out of favor with the general market. Both offer opportunities to buy stocks at low prices.

If you’re gambling, there’s a very good chance that you’re buying on trends. That means you might be a buyer even in rising markets, or that you might be focused primarily on the hot stocks of the day. You’re buying on the current trend and betting that trend will continue in the same direction for long enough that you’ll be able to make money and move on.

The Importance of Fundamentals

Investing is concerned with valuation measures, such as price-earnings ratio (P/E) and book value. The investor will also be concerned with a company’s position in its industry, the competitiveness of its product lines as well as new products and services under development. Investing will also involve careful consideration of a company’s management team and what its experience and management style are.

Gambling might involve largely ignoring fundamentals, under the assumption that if a stock is performing well, the fundamentals must be right.

Gambling might also seek to exploit certain potential speculations, such as take over candidates. The gambler might specifically seek the stock of companies that are considered likely acquisition targets. While that can be lucrative if it plays out, the game is usually over as soon as the takeover occurs, after which the stock is sold. The gambler never bought the stock for its long-term potential but rather on the expectation of the outcome of a single event.

Diversification as a Dividing Line

Since investing is more concerned with fundamentals and the long-term, it typically involves diversification into various stock sectors and asset classes. An investor’s portfolio will usually contain a mix of stocks, bonds and cash, with the stock portion spread out over various sectors, including growth, emerging markets, technology and natural resources. Investing is about building a mix of assets likely to grow over decades.

Gambling is usually focused on chasing return. The gamblers money will usually be tied up in the best performing investments at the moment. It’s not that a gambler won’t diversify at all, but more that he’ll be more likely to load up his portfolio with the best performers. For example, if energy stocks are performing well, he might have 70 or 80% of his money in that sector alone.

It’s a strategy that can pay off handsomely while the trend is in motion. But when it stops, the gambler usually gives it all back and more.

What do you think the differences are between investing and gambling?

Kevin Mercadante

Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids.

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6 Comments

  1. When you mentioned gambling, I immediately recalled the Facebook fiasco. Ultimately the people who hang in are going to do well but initially they had poor results. An investor has to be doing research so carefully and completely ignore the opinions of those that have potential interest in a stock price. This was clearly demonstrated with all of the superlatives issued by the underwriters about Facebook.

    1. Hi Ken–I think there’s a lesson in there too. Never buy into a stock when there’s a lot of fanfare. Getting caught up in the emotions of the moment isn’t investing, it’s gambling. The investor buys in when things are quiet and the fundamentals are right. Buying into fanfare is following the herd and thinking that so many people can’t possibly be wrong.

  2. @Marvin- Boom! Well said.

    I think Benjamin Graham made the distinction pretty well when he said: “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” (From The Intelligent Investor ((I happened to have it on hand lol)))

    As far as speculators go… Well, we do a little more analysis than gamblers, I’d say ;p

  3. The difference between investing & gambling is simple. Investors view stocks as businesses that they acquire that pay them on a regular basis, everything else is gambling!!

    1. Completely true until football Index arrived. Traditional gambling is always in favour of the bookmaker, only a few professional gamblers can make money.
      Football Index is a gambling company, its only available in the UK and Imnot trying to get you to try it out, I couldn’t care less. Just I am really disappointed with the returns from the stock market. You get ads from investment companies stating in the small print that 80%lose money, that is terrible. The bookmaker in this case doesn’t profit from your loss, they profit from your sells and when people decide to instant sell rather than sell to market.
      The advantages here are, unlike the stock market, we know a lot more about the company (footballers) we are buying into and it’s a lot more enjoyable, that is why I think so many guys have pulled their money out of woeful returns on Isas and have earnt more in a few months than they have in a year’s on isas. I’ve had isas and the returns have been terrible. I’m currently 38% in profit in just over 2 years on football Index and I’m not the odd one out, the majority are in profit. Lots of financial advisors and accountants are now putting there money in as they have seen that for the average guy on the street it has so far proven to be a far better place to put your money. Of course to those like you involved in the stock market and no nothing about how it works they always see it as a huge risk, whilst happily taking years to earn a few % in returns.

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