There is a thin line that differentiates investing and gambling.
We might consider professional gamblers—poker players, for example—a breed of speculative investors. Of course, we might also call investment professionals who take wild risks in financial markets gamblers. No matter how skilled the card shark or how practiced the investing maven, one thing is certain: in cards, as in the stock market, there are no guarantees.
Whether we gamble or invest, we take risks in pursuit of potential rewards.
We risk a dollar on a lottery ticket for a potential to win ten million dollars, we risk $25 on a hand of blackjack for the potential to double our money, we risk $5,000 to buy a penny stock for the potential it will triple in three months, or we risk our life’s savings in the stock market for the potential to earn consistent annual returns.
Each risk carries vastly different odds (and potential returns). At the one extreme, the odds you will lose your dollar is good; of winning the lottery, not so good. On the other extreme, the odds of making a modest return on a long-term investment in the stock market is good; the odds you’ll lose a chunk of your savings is much lower.
But are investing and gambling the same? Let’s use an example to find out:
How Three People See Risk
The following describes the attitudes toward gambling and investing held by three individuals: a close friend, my sister, and I.
L (My Friend)
- The Gambler: L became an avid poker player after learning the Texas Hold ‘em in school. He would attend casual tournaments with buy-ins of up to $20 on a regular basis. Also, L funded an account for online poker with at least $400.
The Investor: L took much interest in the stock market in college as well. He started off small with about $1,000 in a brokerage account. By his senior year, he had an account valued at about $60,000, made possible with $20,000 in margin and $15,000 in credit card balance transfers. Obviously, L doesn’t mind risking borrowed money if he believes it can earn a return. Likewise, L believes it is naïve to leave money in a high-yield savings account if the stock market can offer higher returns.
J (My Sister)
- The Gambler: J has proclaimed that she would never play poker with real money, although she has played a few games “for fun”. J wants to understand the game and enjoy it with friends, but refuses to wager real money.
The Investor: J does not own any investments whatsoever. Her ideal method of building wealth is a stable, high-paying career. She has shown interest in the stock market and even built a virtual stock portfolio, but that’s where her investing stops. Instead, J funnels most of her cash into her safe but stagnant high yield savings account.
- The Gambler: Though I am fond of gambling, I rarely put real money down. Aside from occasional friendly poker games, I have only participated in a few “real money” tournaments, none with a buy-in of more than $5. I too caught the online poker bug a while back, but I only funded an account with $25.
The Investor: I am a conservative investor, but an investor nevertheless. I have roughly $3,000 in a Roth IRA invested in mutual funds and ETFs, nothing yet in individual stocks. I believe investing is necessary in order to prosper, but I take the safe approach by investing in index funds.
This evidence is anecdotal, sure, but I believe that the way a person gambles can predict how that person will invest, and vice versa.
The parallels between gambling and investing are interesting, but you’re probably starting to ponder a very valid question: Why should we care?
Because we can use the similarity between gambling and investing to measure our own ability to stomach risks and, as a result, make better investments.
Take, for example, the following ubiquitous investing advice:
Your portfolio should reflect your risk tolerance.
That makes sense, but how are you supposed to know what your risk tolerance is? There’s the general rule of thumb that you want less risk as you get closer to needing the money you have invested (in most cases, retirement). But that’s just the start. No two investors are the same.
But if you like a little gamble in your life, in other words, you’re the type who sits down at the blackjack table instead of watching over your friends’ shoulder, chances are you’ll enjoy the ups and downs that come from riskier investments. On the other hand, if dropping a quarter in a slot machine seems like the most foolish use of 25 cents you can think of, you might be more comfortable with conservative investments.
Obviously, the smart investor strives to make sure even aggressive investments are more than just gambles. And a gambler should know that house always wins and that gambling is entertainment…not an investment. Still, the parallels between Wall Street and the Las Vegas Strip endure…and continue to intrigue.
How does your gambling attitude compare to your investing mindset? Does your risk profile for investing deviate from that of gambling? Share your thoughts in a comment.
About the Author: Simon is a recent college grad living in Brooklyn. He writes for an interest rate-tracking Website and maintains his own personal finance blog, the Realm of Prosperity.