Is Investing in the Stock Market just Gambling?
When we pick a stock, are we just making a bet? It sure seems so. Even the terminology we use when we talk about investing makes it feel like we are heading to a casino. We talk about making a “bet” on a stock and. When the stock is doing well and we want to take some earnings and lock in the profits, we talk about “taking profits off the table”, with the reference to a gaming table. When we do that we say we are “hedging our bets”. We’ve also heard of day traders who spend their time looking for small signals that a stock is going up or down, trying to capitalize on small movements in the market, typically buying and selling the same day.
According to Webster’s, there are two main definitions of "gamble": 1) to play a game for money or property; 2) to bet on an uncertain outcome. Let’s look at each of these definitions of gamble.
“To play a game for money or property”
We are certainly putting money at risk by investing in the market but is it a game? No, it is very serious, with billions won or lost in a day and sometimes in a few hours. So, investing partially meets the first definition.
“To bet on an uncertain outcome”
The market is definitely uncertain and despite every effort to predict its movement, there is plenty of research that most active stock pickers do worse than those who adopt a more passive strategy, including the famous book by Burton Malkiel (A Random Walk Down Wall Street) where he proved that monkeys throwing darts could outperform the market. So, investing fully meets the second definition.
We can conclude that investing is a form of gambling but there is one major difference that should allow you to continue your good investing habits without having to start going to Gamblers Anonymous sessions – in “traditional” Gambling (casino, lottery) there is an advantage to the house and, on average, the player will lose money. The ‘best” game in an casino is normally Blackjack and with the standard game, a player betting $100 will get back $98 or $99 on average, depending on the specific rules and assuming the player has perfect strategy. If you make your bets outside the casino and, for example, bet your friend on the outcome of a sports game, it is still a zero-sum game, with one person winning only as much as another person loses.
Investing in the stock market is not a zero sum game because stocks are appreciating assets. They represent shares in a company that is working hard to make itself more valuable. And as we see when looking at long term graphs of stock market performance, companies have, for the past 100 years or so, been successful at creating value and investors have, benefited from that value creation at a rate of about 7% per year (after inflation) over the very long term.
Sending in the monkeys to pick numbers on a roulette wheel will lead the average person to lose money. On the other hand, sending in those same monkeys to pick stocks will lead the average person to make money.
Yes, investing is, by definition, a form of gambling but with this gamble, over time, you’ll be a winner.