How is investing different from gambling?
I had a friend of mine ask this question. It’s a great question because when you start to think about it, it forces you to clarify the rules you need to avoid losing money.
One of the differences is gambling involves games of chance that are designed to separate you from your money. As an example, let’s use the lottery.
The lottery has a prize for those who buy tickets. However, the odds of winning are usually pretty slim. Usually in the one in a million category.
You might be able to improve your odds by looking at the past winning numbers. Seeing that the number 16 has been a winning number more times than 34 might give you an edge but it still doesn’t ensure you win the game. You could buy a million dollars worth of tickets, that have an arrangement of the most winning numbers and still end up with the wrong numbers.
With investing, there’s still a chance we’ll lose money but our efforts to improve our odds is rewarded by reducing the risk of that happening.
For example, when I start considering a company as an investment, I can look at its financial statements. It’s financial statements give me a grasp of how the company has been performing in the past. Seeing it’s revenue or equity increasing or decreasing will tell me a lot about whether the company is a worthwhile investment.
Besides financial statements, you can find out how much the CEO owns of his/her own company stock. If you see the CEO has a lot of his/her own money invested, they’ll be incentivized to make decisions that benefit shareholders.
There are many other ways investing differs from gambling and I might get into them in another post. For now though, remember gambling is mostly luck, investing is more about staying out of trouble with research and a having a long term plan.