Why Investing is NOT Like Gambling

5857835480_fa4df9162a_zHave you ever heard someone say that if you invest in the stock market you mine as well be gambling?  Although there is risk with any investment I always have to pause when someone says that the stock market is like one big casino where investments are wagers and returns are based on chance. As someone who has worked in the casino industry as an auditor and regulator, I will be the first to tell you how untrue that statement is and here’s why:

 The Power of Longevity

In a casino environment, it’s imperative to keep guests within the facility as long as possible. Have you ever noticed that there are typically no windows or clocks around the gaming floor? In addition, most properties strategically place their restrooms and restaurants in locations where you have to walk across the gaming floor to get to. Go to some of the bigger Las Vegas casinos and they manage to design the floor plan to easily direct you into the gaming area with signage placed a bit more discreetly showing you the way out. At the end of the day, as a player you are statistically at a disadvantage to the house in every game on the floor. Therefore the insider casino mantra will always hold true: “the longer you play, the greater you lose.”

Investing in the stock market is exactly the opposite of this idea. History has shown that the longer you invest, the greater your returns. Since inception, the average annual return for the S&P 500 is approximately 10%. Year over year there will be fluctuations and bear markets, but over the long-term you have to stay in the game to reap greater returns. Warren Buffet said it best, “over the long term, the stock market news will be good.” Maintaining a disciplined saving plan and continuously invest with a long time horizon in mind. In fact, unless you are re-balancing your portfolio you shouldn’t even look at your investment performance day to day, week to week or even month to month. Trust the process and the insider investor mantra will always hold true: “the longer you invest, the greater you win.”

Compound Returns

In a casino, gambling is a series of discreet wagers. Although you can increase your bets and watch your chips grow, you never capture the waterfall effect that is compounded market returns.

The most powerful finance concept for an investor is compound returns. Many times I’ve sat in front of a group of friends explaining (with the urgency of some type of addict) the importance of investing early to capture the power of compound returns. These conversations are typically met with blank stares until I can break down the impact that compound returns have on the value of your investments. Let’s look at an example, and say you have $100,000 saved for retirement. For simplicity sake, we’ll assume you never save another penny and that $100,000 earns 7% annual returns for 30 years. You would end up with $761, 225.50 after 30 years of investment returns. Now, let’s take that same example of a $100,000 and say you earned 8% annual returns instead of 7%. Now your savings have grown to $1,006,265.69. This shows the profound impact of compound returns due to a modest 1% increase in your annual investment return. With 7% you’ve done fantastic, with 8%, you’re now a millionaire. Take a look at Bank Rate’s simple savings calculator to test out the power of compound returns to your retirement nest egg. It’s easy to see that long-term investing in a balanced and diversified portfolio is key to attaining your net worth goals and by far will outweigh the short-term ups and downs of the market that lead many people to consider it gambling.

Risk vs. Reward

Have you ever sat at a blackjack table and played a few winning hands? Suddenly the rush of beating the house fills your body and you feel incredible. Your chip stack is growing and you feel as though you’ve discovered the secret to quick cash. Keep sitting at the table a while and pretty soon that magnificent feeling is sure to dwindle away into an empty hatred for gambling as the dealer collects the last of your chips. That is the very reason that players are so attracted to gambling, it’s a high risk high reward environment. Your entire wager can be lost (and likely it will) or it will double and you’ll see an immediate 100% return.

Now let’s consider investing in the market. I’m not talking about chasing penny stocks (which likely is closer to casino gambling), but investing in a diversified and balanced portfolio that is heavily weighted toward large cap blue chip companies. Sure there’s risk of an economic downturn or a large market correction. But history has shown that over the long-term the market will always create positive returns. Every investment that you “wager” has the risk of depreciating in value, but over the long-term the potential reward is much higher with your funds benefiting from compound returns. Based on the risk-reward ratio can you really consider investing in the market as gambling?

If you’re a thrill seeker and live life on the edge, the casino is the place for you. For the more conservative folks… let’s just maintain a healthy blood pressure, sit back, drink a beer and watch that money work for us.

______________

Photo by Images Money

12 comments
Petrish @ Debt Free Martini
Petrish @ Debt Free Martini

I am a firm believer in the power of compound interest.  If I had known how compound interest can effect your money I would have starting saving seriously years ago.  I was raised to not gamble and I am not embarrassed to say that I too looked at investing in the stock market as another form of gambling, but now realize that they are different.  

Financial Tour Guide
Financial Tour Guide moderator

@Petrish @ Debt Free Martini I am definitely a believer in compound interest.  It drives many of my purchase and savings decisions knowing that a dollar today is worth so much more in the future. I started early, but I too wish I had started even earlier.  Imagine if you opened an IRA at 18?! Or if your parents set up a custodial IRA even before that?!

DC @ Young Adult Money
DC @ Young Adult Money

I think there are a few issues people run into.  Like Andrew said below, one big issue is people avoiding the stock market altogether.  Another issue is people putting too much money into casino gambling not realizing that it's 100% entertainment and long-term you WILL lose.  I think poker is an exception.  It's not black and white, but there are people who will win long-term and conversely those who will lose long-term. 

Financial Tour Guide
Financial Tour Guide moderator

@DC @ Young Adult Money That''s very true.  If we take an analytical approach to our money and base decisions on data, it's clear that we're always at a statistical disadvantage in a casino (with the exception of poker).  However, historical stock market data has shown that positive returns over the long-term is a near certainty.  I'll choose the latter of the two for my nest egg.

DC @ Young Adult Money
DC @ Young Adult Money

@Financial Tour Guide @DC @ Young Adult Money I like the fact that you can really diversify in the stock market, too.  As we were discussing on another post there is always the option of having your money exposed to other country's currencies, different companies abroad, etc.  It's kind of ridiculous how easy it is to diversify your investments in the stock market.

Financial Tour Guide
Financial Tour Guide moderator

@DC @ Young Adult Money @Financial Tour Guide That's a great point.  If you think about other investments types, diversification is much harder to achieve.  If you're starting a small business or investing in real estate for example, imagine how difficult it would be to gain international exposure.

Andrew LivingRichCheaply
Andrew LivingRichCheaply

Good points, unfortunately a lot of people do have that misconception and avoid the stock market to their financial detriment.  If you're making short-term bets and/or investing in fly by night penny stocks, then that is more akin to gambling.  I'm a big proponent of index funds though as I just don't have the time and expertise for individual stock picking.  I do invest in individual stocks but my main portfolio is in low cost index funds.

Financial Tour Guide
Financial Tour Guide moderator

@Andrew LivingRichCheaply I'm an index fund investor as well.  When seasoned fund managers have been proven to under perform most of the key indexes over time, then why pay the additional fees? Better to select quality index funds with the lowest expense ratios and let it sit long-term. 

Jason@Islands of Investing
Jason@Islands of Investing

Such an important message to get across to people. It's like a casino only if you invest completely blindly, and make short-term bets. Otherwise the odds are well and truly in your favour!

Financial Tour Guide
Financial Tour Guide moderator

I couldn't agree more Jason. If you chase short-term returns the market can present plenty of risk, but over the long-term the right portfolio will provide great returns.

Christina@EmbracingSimple
Christina@EmbracingSimple

You've shed some great light on investing here! Investing is something that I just don't know enough about to feel confident in investing it wisely, so I leave that to my hubby. But I feel like at this point I'm just making excuses and really need to learn how to wisely invest and actually get my hands dirty with it. It actually sounds like a lot of fun!

Financial Tour Guide
Financial Tour Guide moderator

Thanks Christina! The hardest part is getting started. As soon as you commit to taking the first step I think people find that investing is fairly simple. When it comes to investing your nest egg you may never feel 100% confident (You'll always be waiting for that big correction). But if you do your research and establish a diverse portfolio, you can trust that the returns will come over a long time horizon.