Wednesday, 20 July 2011

Is the stock market 'just gambling'?

I've often heard the phrase, 'playing the stock market is just gambling', or versions thereof.

Is it true that buying shares on the stockmarket has similar monetary risks to activities such as a night at the bingo, visiting a bookie, a casino or playing online poker?

Considering that many of us have money invested in the stockmarket through personal investments, windfall shares and other financial instruments, direct and indirect, it would be incredibly disingenius if playing gambling games and investing in the stockmarket were in the same risk class.

There is much information widely available on the internet that shows that the stockmarket offers a better rate of return than other asset classes, never mind gambling, especially over extended periods of time. I'm not going to rehash the statistics here because they vary according to time period taken and are the results of a simulated model. If you want the numbers/ graphs, Google is your friend.

Taking the 10 year view is, for most people - me included, a bit too far into the future to be meaningful. I am therefore going to talk in terms of my experience as a private but reasonably confident investor who believes that, over time, the stockmarket will offer me the best rate of return I can get.

In this post, I am going to explore the case of buying shares on the stockmarket rather than short term trading, dealing in derivatives or shorting stock. Also when I say gambling games, I mean where a company is involved rather than an evening of beer and poker in your mate's back room.

First, lets see how Wikipedia defines gambling:

Gambling is the wagering of money or something of material value ('the stake') on an event with an uncertain outcome with the primary intent of winning additional money and/or material goods. Typically, the outcome of the wager is evident within a short period.

What a gob full!

When definitions are so verbose , you can guarantee it is because the subject at hand is not easily defined. There is actually no single, universally agreed definition of what 'gambling' is.

However, it is generally held that gambling is:
  1. When two or more people agree to take part in the activity (usually 'the house' or 'a book maker' and the person who wishes to gamble).
  2. Money (or some other tangible asset) is transfered from the loser to the winner.
  3. The outcome is uncertain.
  4. The result is determined, at least partly, by chance.
  5. It is an active experience and can be avoided by not participating.

The three main similarities between gambling and investing on the stockmarket is that:

  • Directly or indirectly, at least two people must participate in the activity.
  • Gain or loss depends on an uncertain outcome. 
  • There is an element of chance involved.

And now the differences:

  • bets are placed against a house or bookmaker (who are in the business to make a profit). There is no equivalent in the stockmarket - the broker gets paid for providing the broking service, not for 'wins' or 'losses'. 
  • most gambling activities are time or event defined. The stockmarket is user defined in that the investor or trader can roughly choose the entry and exit points.
  • there is always a winner and loser in gambling. It is not necessarily the case with stock market investing.
  • nothing goods or services are bought or sold during gambling pursuits. A share is a thing fraction of a company so a tangible asset is transferred. 
It has been said that life is a series of risks (gambles), opportunities (chances). Even the phrase, "he makes his own luck" could be restated as "he makes the best of the use of the cards life has dealt to him."

I would say that anyone who plays the National Lottery is gambling - it certainly fulfils every one of the five criteria for gambling, as outlined earlier. Many millions of people, who would not consider themselves gamblers or risk takers, play the National Lottery without much thought, although the odds are quite frankly rubbish. So maybe it isn't a question of how risky an activity is but how much one has to risk or how the risk is packaged.

If you consider that probability is a continuum that ranges from 0% (will never happen) to 100% (certain), the only things in life that are certain, and therefore aren't gambling, are death and taxes! (according to the old cliche). The best that we can say about playing gambling games and stockmarket investing is that they are both somewhere on that continuum line. Where each individual places them will go some way towards determining  their attitude towards the activity.

So yes, in a way, and to a degree, investing in shares on the stockmarket does have risks and could therefore be construed as a form of gambling.

In my pursuit of Growing My Own, I would rather take my chances on the stockmarket than down the bookies, at the casino, participating in online gaming or playing the slots because I believe the probability of me making money on the stockmarket is higher up the continuum than playing gambling games.

Aside: I still remember the time I won £40 at Treorchy Bingo Club on holiday in Wales back in the day.