It’s Aintree Grand National Month and one of those times when I think I should do some homework into the horses running before I make a bet. I say this every year, but do I ever do homework? The answer is no. If I do bet, I choose my horse based on its name or even the colour of the jockey’s silks. Otherwise, with the time spent researching, I’d want more certainty on the return for my time invested. It’s this quandary that has led me to think about gambling versus investment.
Compare and contrast
There are lots of people who say: “investing in the stock market is just like taking a gamble”. So, in this editorial I want to compare and contrast the two.
• Gambling is defined as staking something on a contingency. It means risking money on an event that has an uncertain outcome and heavily involves chance.
• Like investors, gamblers must carefully weigh up the amount of capital they want to put ‘in play’.
• Most professional gamblers are proficient at research and risk management. Just like a stock investor, they do their homework. However, in the case of horse racing they can research the race, the owner, the jockey, a horse’s bloodline and its track record. They are seeking an edge, but the outcome is still a win or lose with nothing in between.
• Investing is committing capital to an asset, like company shares, with the expectation of generating an income or profit over the longer term. You are investing in the future of that company.
• The expectation of a long-term return in the form of income or price appreciation is the core principle of investing.
• Risk and return go hand-in-hand with investing. Low risk generally means low expected returns, while higher returns are usually accompanied by higher risk to the capital.
• You will analyse a company’s past performance to see its reliability in providing a return into the future. You may study its share price movements to get an idea of its future trajectory, but in deciding to allocate your monies to an investment you are making a decision that the company will allocate your capital to deliver a return over and above the costs of you investing in it over the longer term, to make you wealthier.
Risk and choice are both involved – you decide to put your money at risk to get a better return on it – and the over objective is to minimise risk while maximising profits. Both investors and gamblers will look to the past, study historical performance and current behaviour to improve their chances of making a winning move. Information is invaluable in gambling as well as stock investing. But there’s a distinct difference. Stock and company information is readily available. The information available to gamblers may be limited.
Gambling is typically a short-lived activity, while investing is a long-term activity for a future return on the money you invest. When it comes to gambling, the house always has an edge—a mathematical advantage over the player. That competitive edge increases for the house the longer they play as they have a greater history on which to offer the odds on. In contrast, the stock market constantly appreciates over the long-term, the value of your investment will continue to rise, you are investing the future of the company until you sell your shares. Over time, if you keep investing, the odds will be in your favour as an investor.
What’s more, there are very few ways to limit your losses with gambling. Investors, however, may use a range of risk mitigation tools such as asset diversification; buying a range of assets with different characteristics to mitigate the overall risk to capital and hopefully increase the average return.
If you decide to invest in a company simply because of its position now and this is your sole reason that is, in effect, gambling on the company’s fortunes. It’s no different to betting on the only grey horse in the Grand National in how you have arrived at your decision as you have only looked at one aspect and that is the cost to invest.
Making an investment should be a disciplined process and your decision should be based on allocating your capital to an investment in line with your investment objective and asking yourself the question: will I be able to keep the monies invested for long enough to benefit from a positive return?
If you’d like some advice on how to answer that question, you can arrange a free consultation with Pauline via email: email@example.com, calling 01246 550521 or simply popping into our offices on Glumangate in Chesterfield. We’ll see you soon!
Post written by Pauline Fernandes, Independent Financial Advisor with Jones & Co
Risk warnings: Pensions and investments go up or down in value and on encashment you could potentially get back less than originally invested. The contents of this article are for information only and do not constitute financial advice. Always seek professional guidance when investing in risk-based investments.