Investing is one of the most productive activities we can do with our money to improve our financial situation and grow wealth over time. However, there are several factors that tend to hold would-be investors back from buying their first shares in a company. One of the largest factors is fear born from a dangerous myth: that investing is like gambling.
This myth has many believing that when you make an investment, you have about the same chances of turning a profit as you do in a game of blackjack or poker.
But the “investing is like gambling” myth couldn’t be farther from the truth. When gambling, the house always has the advantage. When investing, the educated investor is the one with the leg up on the market.
Why Is This Myth Around?
The “investing is like gambling” myth was born from the fear of loss — one of two emotions that are important to keep in check when investing. The idea behind the myth is that you can lose money in the market just like you can lose money at a game of poker — that success or failure mostly boils down to luck.
Whether playing a game of poker or making an investment, you will have to shell out at least a few bucks to get started. You have to put some money on the line in order to participate. If you make the wrong moves in the market, these moves will lead to losses. In some cases, the loss of your entire investment can happen. Of course, the same goes for a game of poker.
There’s also the apparent element of randomness or luck driving the outcomes. The day-to-day movements of the markets are notoriously difficult to predict, just as you never know what card will be dealt next or where the spinning wheel will stop.
With these similarities in mind, many people seem to have made a connection between investing and gambling.
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Why Investing Is Nothing Like Gambling
Although money must be risked and can be lost both in a game of poker and in the stock market, there is one critical difference between the two.
Informed decisions are against the rules in gambling. When playing a game of poker, you can’t walk around the table and take a peek at the cards your opponents hold. You can’t sit in the dealer’s seat and check to see what cards are left in the deck. In a game of poker, you are blind to the details that could give you more complete information and increase your odds of winning.
By contrast, informed decisions are not against the rules, but rather are the key to success in the stock market. Virtually all experts suggest that you gather as much information as you can before making an investment. It’s like having the ability to look at your opponents’ cards in a game of poker or being able to predict when a slot machine is about to hit the jackpot.
Of course, investing will always come with risk. Even if you do your research, you will lose money at some point. But you can protect yourself and set up systems that ensure that, when you win, you can win bigger than you lose. You can use tools like stop losses to limit losses on any given trade, or margins to expand your gains, none of which can be done in a game of poker.
Moreover, even the best game in a casino gives you the ability to win 49% of the time. Many professional investors and traders alike tend to strive for a 70% win ratio. Most importantly, you have the ability to research and tip the scales in your favor when making an investment, a move that would be against the rules in any gambling setting.
Why Is This Myth Dangerous?
Myths often come with dangerous consequences. The myth that investing is like gambling is no different. Unfortunately, this myth has likely cost countless investors hundreds of millions — if not billions — of cumulative investing dollars.
The “investing is like gambling” myth is dangerous for two key reasons:
1. It Delays Entry to the Market
When you make investments, you will win some and you will lose some. However, from a historical standpoint, if you leave the money you invest in the market for a long period of time, it will grow.
An important part of this is the idea of compounding. As your investments make money for you, the returns are reinvested, creating more potential for growth across your portfolio. These compounding gains work over time.
A week, a month, or even a year isn’t a long enough time frame for compounding to make a meaningful difference. However, over the life of a long-term portfolio, it can be the difference between retiring a thousandaire or a millionaire.
Take a look at the chart below to get an understanding of the difference compounding gains can make in our portfolio and just how much delaying your entry into the market will cost you over time. The chart shows what happens when gains are compounded over time from an initial investment of $100 and a recurring weekly investment of $35 (or $5 per day):
|Year||Portfolio Value||Five-Year Growth|
(Data based on a 9.8% historical annual rate of return of the S&P 500)
The chart above shows that, although you invest the same amount of money in years one through five as you do in years six through ten, your returns nearly double. This process continues such that by year 30, your five year returns reach nearly a quarter million dollars, all from investments of just $5 per day and compounding gains. The longer you’re invested, the bigger your returns, with the most significant compounding growth taking place in the later years.
Imagine you plan to invest for retirement in 30 years. If the myth that investing is no better than gambling did nothing other than hold you back from starting to invest by five years, it would cost you more than $130,000 in compounding gains.
2. It Leads to Uneducated Investments by Beginners
Losses due to lack of compounding gains aren’t the only risk associated with the “investing is like gambling” myth. The other big issue is that it drives beginner investors to make horrible investing decisions, often leading to immediate losses and, for some, scaring them out of investing in the market for good.
It’s common for a beginner investor to open a stock chart knowing little about the company or what the chart tells them. If they see gains in a stock or pick a particular company for any number of reasons, they take the gamble without doing their due diligence to make sure the stock they are buying represents a quality company, and without anything more than a hunch that the stock will move up.
After all, if investing is just like gambling, then picking a stock is no different than betting on a roulette wheel — all you need to do is make an investment and you have a chance to make money, right?
Wrong! Making uninformed moves like these can open you up to multiple risks, including but not limited to:
- Buying At or Near Resistance. Resistance is a technical indicator (more on these later) that suggests an overbought stock will start to be sold, leading to declines. Buying for no other reason than a stock is moving up subjects you to the risk of buying at or near resistance. If this takes place, the stock is likely to fall dramatically, leading to substantial losses.
- Buying a Worthless Stock. Technical events like short squeezes happen around worthless stocks all the time. These events lead to dramatic gains, often in the hundreds of percent, over a short period of time. Beginners who think investing is like gambling may see other “lucky” investors making huge profits rather suddenly, and buy into a short squeeze just before the reversal takes place. At the end, they are left with shares in a stock that has not only lost tremendous value, but may be nearly worthless and difficult to sell, leaving these investors stuck holding the bag.
In truth, investing is nothing like gambling. Investors should do their research and get a good understanding of what they are investing in before buying stock or any other investment vehicle to avoid significant losses like these.
Research That Will Help You Make Profitable Investment Decisions
Informed investing decisions give you the best chance at profitable outcomes. Here are the types of the information that you should look for when assessing a potential stock market investment.
Fundamental analysis is an assessment of the overall health of the company and its prospects for future success. Before making an investment in any company, you need an understanding of what the company is, what makes it unique, the value proposition it proposes, and its financial standing. These factors will play a large role in whether the stock representing that company moves up or down in value. Key fundamental information you should look for includes:
- Products or Services. First, search for information surrounding the company’s products or services. What are they? What problems do they solve? A company that represents a strong investment opportunity will offer products or services that solve a common problem for either a mass market or a specific group of people.
- Market Potential. A company might have the best poop polisher in the world, but if no one is interested in polishing feces, it’s not going to sell very well. Do some research to determine the size of the market into which the company’s product or service is sold. From there, take a look at competing options and how much of the market share the company you’re interested in controls. Strong investment opportunities will either have little competition in a niche market or have a large percentage of market share in a large market.
- Intellectual Property. The best investments are made in companies that have strong intellectual property protection through a series of patents, trademarks, and copyrights. If a company doesn’t have patents on proprietary technology, any other company could incorporate that technology into their own products or services and compete with the company you’re interested in.
- Revenue and Earnings Growth. Companies worth your investing dollars will have a history of strong revenue and earnings growth. Before making an investment, look into the last four quarterly financial reports from the company you’re considering. In particular, look for consistent growth in revenue and earnings per share.
- Innovation. No matter what industry the company is working within, innovation is going to be key to success. Even companies that are the kings of their respective sectors at the moment can be overthrown as a result of a lack of innovation. Just take a look at what happened to BlackBerry when other, more powerful smartphones came along. Before investing in any company, go to that company’s website, read its press releases, and look for other information online surrounding the company’s work to create new options for the audiences it serves. With continued innovation comes the potential for continued growth.
Technical analysis is the search for patterns in the movement of stock prices that help to predict how they will move in the near future. There are several technical indicators that investors and traders use on a daily basis. Many of them would require an entire article to explain. Nonetheless, when making long-term investments, there are three technical indicators that you should consider before making your move.
- Support. Support is a term used to represent the price at which a falling stock is likely to change direction and start moving up. Tracking support is as simple as looking at a historical stock chart and drawing a line connecting the bottom-most points in the chart. Following this trend line will give you a good idea of where support lies. Investments are best made as close to support as possible, giving your money the largest opportunity to grow as possible.
- Resistance. Resistance is a term used to represent the price at which a gaining stock will likely change direction and start falling. To find the resistance line, simply draw a line to connect the highest points in a stock chart. Following this line gives you an idea of where the stock will find resistance. You typically don’t want to buy a stock near resistance, as doing so will open the door to potential losses.
- Moving-Average Crossover. Moving averages track the average price of a stock over a period of time, which helps to show trends in its movements. A moving-average crossover is when the 30-day moving-average trend line crosses either above or below the 90-day moving-average trend line. If the 30-day moving average crosses above the 90-day, it’s a signal that the stock is headed up. If the 30-day moving average crosses below the 90-day, it’s an indication that the stock is on its way down. Before making an investment, open a stock chart and add the 30-day and 90-day moving average indicators — usually a drop-down box on the chart depending on the provider you use. Look for the most recent point at which these averages crossed and the direction they are headed to get an idea of what to expect from the stock ahead.
Pro tip: There are several free and paid stock screeners available. Each will help you look for good investments based on different technical and fundamental patterns. Learn more about our favorite stock screeners.
Not all myths are dangerous, but the notion that investing is just like gambling is one of the most financially dangerous myths that exists today. Not only does it hold potential investors back from getting started, but it’s also known to cause beginner investors to make big mistakes.
Investing should be a carefully calculated process born in research and driven by the thirst for financial freedom. Gambling is a game, born for entertainment and driven by the perception that one card, one turn of a handle, or one lucky dice roll can make you rich.
The two concepts couldn’t be further apart from each other.
So, don’t let this myth stop you from getting your investment portfolio going, or let it lead you to treating investing like gambling. Instead, get started as quickly as you can to take advantage of compounding gains, and do your research to make sure that the figurative deck is stacked in your favor.
How do you view investing? How does this perspective influence your investment decisions?