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?
Time to dive in to the main differences between these two strategies and how you can set yourself up for long-term investing success.
Gambling vs. Investing – What's The Difference?
Investing is the process of putting resources into something with the anticipation of future returns. Typically, this involves putting money into companies or assets with the expectation that they will appreciate in value, produce income, or accomplish both goals.
In contrast, gambling involves taking bets for the potential to reach a desired result. Bets don't have to be stacked against you for it to be gambling either; even a bet that's heavily skewed in your favor is a bet if you're playing a pure game of chance to achieve a result.
Key Differences Between Investing & Gambling
By definition, gambling and investing are quite different. However, the lines can become blurred when you think about strategies like buying individual stocks. After all, isn't investing in companies a form of gambling if it's impossible to know the end result?
Well, there are some key distinctions between investing strategies and pure gambling, so let's explore them.
Long-term vs. Short-term Focus
One of the most obvious differences between gambling and investing is the timeframe that's typically involved with either approach:
- 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 short-term price appreciation, not long-term dividends or 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 undervalued stocks.
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.
We've seen plenty of examples in recent years, with trend-chasers going after cryptocurrencies, DeFi, NFTs, and the metaverse. And while some investors can strike it big and ride Dogecoin to the moon, many more are left holding the bag. This is the risk of investing based on trends and not investment fundamentals, which I'll cover right now.
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. After careful consideration of a company, value investors may decide to invest if the stock in question seems to be trading for less than its intrinsic value.
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.
Many investors also dabble in alternative asset classes for even more diversification. This could mean investing in real estate, commodities, or even more speculative ideas like artwork or wine. But speculative investments aren't automatically a gamble as long as they're part of an overall strategy to create a diversified portfolio. And, many alternative assets are often great inflation hedges, so there's an argument for having some in your portfolio.
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.
At the end of the day, some people will strike it rich with investing, and others will with gambling. But at Investor Junkie, we're firm believers that the odds are better stacked in your favor if you stick with long-term investing and keeping things simple.
As mentioned, there's nothing wrong with investing in trends or alternative asset classes to mix things up. But the bottom line is that diligent investors do their homework, know their goals, and act accordingly.
Besides, it's easier than ever to invest these days, so it isn't rocket science. Opening an account with an online broker and dollar-cost averaging your way into the market also sounds much simpler than trying to time the next Bitcoin or hot trend.
What do you think the differences are between investing and gambling?
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