Fundamentals of Financial Intelligence
Investing vs. Gambling: What’s the Difference?
Clearing up Substance and Semantics
The distinction of investing from gambling, or what exactly it is that distinguishes market participants from horse betters, is frequently confused in both political/ethical and purely economic terms. Investing is different from gambling because it is not zero-sum; wealth can actually be created or destroyed (there is a lot more of it in the world now than there was in the Middle Ages). To “invest” is strictly to apply capital now with the hope of generating wealth synergistically and extracting it later on with the entire pie enlarged. In a casino or a racetrack, in contrast, your win is necessarily someone else’s loss, either the other gambler’s, or the house’s.
“If you don’t know who you are, the stock market is a very expensive place to find out.” — Warren Buffett
The reason this distinction loses a measure of its meaning in the securities (stock, bond, etc.) markets is that by entering into them you are not strictly, in economic terms, making an “investment”, but rather buying (already finite and created) financial products. The capital backing a stock or a bond has already been laid out; what you are actually buying for your money is the claim to it someone else has already generated. You are buying into a secondary market, comprised of products developed by investment bankers. Its the bank that made the investment, but rather than holding it regular consumer, they make most of their money by reselling the offering on the open market.
A going concern, such as any publicly traded company, is continuing to create wealth, not merely shuffle it around, and any part owner of it can consider himself an investor. But the mighty industry surrounding the dealing in these part ownership positions leads many lay investors (and frankly institutional ones) to treat it in practice like something much closer to gambling. A financial product is an entitlement to future cash, effectively an IOU — and therefore inevitably endures a lag in its face value as long as that cash remains in the future, because future events are uncertain. Of course, the lag is just as likely to be rather greater than less than the present value of said future cash, but this lag creates a secondary opportunity for financial gain, that the financial sector is generally only too eager to encourage. So even though the line is difficult to draw firmly — as for example, how long you need hold a stock before exiting the position to have considered yourself truly an investor rather than gambler — it is vital to understand in your own mind the difference between the two, and which substantively you are doing. Investing rather than gambling means accepting the risk, even inevitability, of a discrepancy between a stock’s face value and the present value of the future cash its ownership entitles you to. Warren Buffett is all the way on one end of the spectrum, investing on the whole only in businesses he truly intends to own in perpetuity, and about which he can thus afford to remain indifferent about the market price of after he’s taken his position. But even if you do not restrict yourself only to assets you are willing to hold on to forever without liquidating, you must understand the fundamental and ultimate connection between the real money a security entitles you to and its market price. The two can experience long periods of wide deviation, but the chickens always come home to roost eventually. Some people get rich paying attention only to market movements (“technical” rather than “fundamentals” investing), seeking nimbly to get in and out before said chickens return, but they are few and far between. And at any rate, such “investment” is in no meaningful sense distinguished from gambling. Some people consistently make money betting on horses; there is certainly an intelligent and an unintelligent way to do that (mostly because it attracts so many who prefer a thrill to financial soundness and thereby divest-able of funds), but it remains a gamble rather than an investment. [There are some technicalists who regard all future cash flows, as well as their present value, to be not only objectively knowable, but perfectly absorbed at every moment into the securities markets, and have made a sizable industry playing on the mysteriously resilient, religious will of many to believe this, under the banner of the “efficient market hypothesis”. I for one prefer to speculate on the present location of Tupac.]
Note that this is a different (if not unrelated) distinction from money generated by work rather than entropy: professional poker players might spend years reading and studying, and there is a reason they are much more likely to win. Conversely, a brilliant opportunity with no catch might well fall into your lap if you are in the right place at the right time that still creates new wealth. Do not confuse ethics with prudence. But neither make the mistake of throwing money at the market to keep up with inflation simply because a stock is safer than a horse an it is what prudent savers do. In Buffett’s immortal words, “If you don’t know who you are, the stock market is a very expensive place to find out.”
