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Investing, Speculation And Gambling

Immediately after I introduce myself as a finance or investment professional, the first question I get asked is "How's the market doing? Is it a good time to invest?" This is usually followed by "So which are the stocks/ sectors do you think will do well this year?"

Immediately after I introduce myself as a finance or investment professional, the first question I get asked is "How's the market doing? Is it a good time to invest?" This is usually followed by "So which are the stocks/ sectors do you think will do well this year?"

In our opinion, if you're asking these questions you are not investing - you are speculating, or worse, gambling. Quite often we notice people confuse one for another and more importantly back it up with their hard earned money. So, how do you differentiate one from the other?

Speculation is the easier one to understand. Assume 2 friends sit together for a game of cards. Both bet Rs 100 each. At the end of the game, assuming that one of them lost Rs 100, the other person would have made Rs 100. Mathematically, it is a zero sum game. The total gains will equal the total losses. Many ‘investment avenues’ that one sees around us are actually speculative in nature, i.e. not all participants can make money at the end of the day. One makes some money at the cost of someone else. Day trading or currency trading is like this. You hope to benefit from the other person making an error of judgement.

Gambling, on the other hand is speculation with a negative outcome for all parties. If 2 people walk into a casino, and assuming there were only 2 visitors in the casino that day, if one person loses Rs 100, the other person need not have made Rs 100. His gain will be much less than Rs 100, say close to Rs 70. The balance Rs 30 will go to the casino. Lottery as a system is also similar. All parties involved, except the casino, walk away collectively poorer.

The first job of any investor is to completely shy away from all activities which resemble gambling. Chances are that you will lose money at the end of the day.

The premise of investing is a positive outcome for all involved. If 2 people invest Rs 100 each, both can take home a sum greater than Rs 200 on a combined basis. All investment options need to be evaluated against this basic principle. Investing is neither a game of chance, nor a bet on the other person being a fool. Contrary to popular belief, equity market investing tends to be a positive sum game over time. One buys into slices of companies which are growing, earning profits, which over time get paid out to shareholders. Companies which fail the test of their ability to make profits and pay them to shareholders are not investments. They are more speculative or gambling in nature.

How does an ordinary person find out which companies are investment grade and which are not? The answer is mutual funds where professional managers with years of experience make these decisions. A further advantage with mutual funds is that you can buy into slices of many companies with small sums of money.

The question then is why do people gamble at all, if the odds are stacked up so much against them? I suspect it is that dream of immediate quick and large gains for some. For others it is the adrenaline rush of winning. We can also ask the same question about investment. Why is it that people don’t always choose good investment avenues? It is probably because investing is a path that requires lots of patience and discipline.

Ask yourself. Are you an investor or a speculator?

If you are buying stocks for that one big win that gives you a 200% return in 3 months like your uncle's friend's cousin, then you are a gambling. If you're deploying your hard earned money to take advantage of short term market movements, you are speculating. You're investing only when you're selecting your options with a realistic expectation of return over a reasonable time period.

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