This question pops out from time to time – what is the difference between gambling and investing? I bet many of us have some idea, but unable to clearly explain what really separates the two. That is why we often see people rushing to buy stocks with a gambling mindset. For most of us, buying stocks and buying 4Ds are all in a mixed bag categorized as ‘money-making opportunities’, as both of them make use of money to make money.
In the book ‘Building Wealth Together Through Stocks’, I have dedicated 4 pages of it to explain the difference. I hope readers take time to ponder over the issues discussed. A financial book of such nature should not be read like a novel. Certainly, in its very simplistic form, it could be easily completed within a day or two. But if one were to do that, he is likely to miss out some salient points. The idea of making it simple is to enable readers associated the salient points with their own experience as a backdrop and draw up important lessons from there. This is the best way to learn financial lessons. As one goes through the book, he should be asking mind-boggling questions like – why the author is doing this and not doing that. If I were in that position at that point in time, what course of actions should I take given the future unknowns. Obviously, in our investing journey, there are always rights and wrongs that we had made when we review things in hindsight. By getting into these pertinent questions, then one can draw out the critical lessons to help frame our financial journey ahead.
Before we start to identify the differences between investing and gambling, let us point out the obvious. Whether we are investing or gambling, we need money upfront. If we do not have money as a form of ‘bet’, nothing works. That said, the huge difference lies in the outcome.
First and foremost, there is the mouth-watering payout. In any form of gambling, the payout is the most attractive part. It is a huge magnet to draw in punters. Take the case of 4D. The first price wins $2,000 on a dollar. The second goes for $1,000. The third gets $500. Even the consolation price gets $75 on a dollar. The ratio between the payout and the outlay is many times. This is the most attractive part of gambling – making ‘big money’ out of a ‘small investment’. Due to this huge difference in the payout against our ‘bet’ or investment outlay, we often see long queues in 4D outlets, especially during times when there are promotions offering strike prices going into millions of dollars for TOTO draws. In investing, however, it is a different story. It is quite difficult to gain even 50% on a dollar within a very short time to begin with, let alone hitting a multi-bagger. It can take years and even decades to do so. In fact, if one were to review his portfolio, some stocks may not even touch 2 x bagger at all.
Then comes the next few points. The best way of illustrating it is to bring out a story. There was once a big-burly 16-year-old teenager, Mike, who liked to play the same old prank on a 10-year-old boy named Jack. Mike flashed out two coin – a 10-cents dime and a 50-cents half a dollar. Every time, when the game was played, the Jack chose the 10-cents dime and he got to keep the coin. It had already been played for 11 occasions, when older boy decided that he should reveal to a common friend, Joe, how stupid Jack was. On the 12th occasion, the Joe decided to witness the game and to better know the level of financial literacy of Jack. Once again, Jack chose the 10-cents dime instead of the 50-cents half a dollar. Unable to control himself, Joe decided that it is time to let Jack knows how stupid he was. In the absence of the bigger boy, Joe spoke, “Obviously, you are not smart enough to choose the high value coin. Don’t you know that the 50-cent coin has bigger monetary value than the 10-cent coin?”. I am quite sure many of us would have the same thought as the Joe, right? Please do not go further beyond this point until you really sit back and think over this issue.
This was the answer from Jack. “I know I am very stupid to choose the 10-cent coin. But if I were to choose the 50-cents coin, he would play the game only once and it is a game over for me. I have played the game with him for 12 times and I have gotten $1.20 so far. I can play this game forever so long as he does not know what I am thinking”.
What lessons can we draw from this simple story? There are, in fact, a few overlapping take-aways:
- In the story, there are two choices and the outcome is one of the two choices. In other words, it is a binary decision. We choose one or the other. In gambling, it is a binary outcome, either we strike or we don’t. But, unlike the above story, the probability of a strike is so low that net probability (in mathematics, we call it expectation) is always in the favour of the house. In other words, if we buy all the possible 4D numbers of $1 each, the returns that we got from all the strikes is still unable to cover the total cost of $10,000 to buy up all the possible 4D numbers. The net effect is that the house always wins. When there are more players, better still for the house. It is the summation of all the net gains from each individual. In investing, there are actually three possible outcomes. One can gain, one can lose and a less obvious one, one can draw or just break-even. In a normal circumstance (or unbiased situation), the probability of the gain and the loss are quite equal, but the probability of the breakeven is significantly less compare to the two. The gain and loss are also not significantly discrete like in gambling whereby we know the payout. While the gains and losses in investing are still discrete, they can span over a huge price range such that the win-loss probabilities can be transformed into a continuous bell curve. So, in effect, some gains and losses are significant while others are not. That explains why some people made big gains while others make small gains out of just one particular stock.
- What attracts me to investing is certainly is not the number of outcomes per trial mentioned above. It is the number of trials that we can play per investment. In the mentioned story, Jack is not worried out about the quantum of each return he played. What he is worried about is that he could only play the game once. This is exactly the situation of gambling. In gambling, the outcome happens only once. In other words, we bank all our hopes in that one and only outcome. For example, in a 4D draw, we place a bet for a certain date, If we strike, we are happy, but if we don’t, we don’t get a second chance. In investing, we get multiple opportunities actually. If we are unhappy with the selling prices (or outcomes) for the day, we can come back another day to sell our investment. In other words, we have plenty of opportunities to buy or to sell an investment. In fact, the opportunity is infinite so long as the stock is still trading and the stock market is still there.
- Another advantage but often neglected point about investing is the timing of the outcomes. In gambling, we have no idea of the outcome. Up until the draw, nobody knows exactly what the outcome is like. Think of a 4D draw. Nobody is certain what is going to come out as the 1st price, or the 2nd or the 3rd. It is a total bet based on luck. It occurs once and only once. But one thing is obvious. We have to place our bet before we can enjoy (or angry about) the outcome. In other words, our action is before the outcome. In investing, due to the multiple outcomes, there are actually precedents to guide us on the trading price. If we are more or less happy with the on-going trading price, we key in our trades. If we don’t, we sit by the sideline to drink coffee and be an observer. Even if we missed out in buying or selling a stock, there is always another opportunity down the road. In other words, we can wait and sit on it. In a certain extent, the outcome comes before our action and we can choose whether to act on it.
- In the story, Jack definitely adopted a long-term strategy. He knew that if he took the 50-cents coin, he could only play the game once. But if he were to take the small gains each time, he could do it over a long time. Over time, the cumulative returns, unknown to the others, surpassed the one-time significant gain. In gambling, the outcome for each trial happens only once. The outcome for the next trial is independent of the first and has to start off with a fresh bet. In others, the two trials are mutually exclusive. If there are more trials, they are also independent of the earlier trials. In other words, we are unable to set a long-term strategy. In investing, it is possible to set up long-terms strategy. If we believe a stock has a good long-term potential, we can consider to hold it long-term. Over-time, we can buy more, accumulate them, benefit from the dividend distribution while waiting for the stock price to go up. This can go on and on, so long as the stock is still trading and the stock exchange continues to operate.
These points are sufficient pointers to help readers relate the lessons learnt with true experiences. There could be more. So, I hope readers draw in their life financial experiences while reading the chapters of this book.
From now till 30 September, the ebook will be promoted at $16 and the physical book for a local address is priced at $18 + postage charge. (Postage charge to be borne by addressee. All purchases to be made via SingPost). Payment for the ebook can be made via www.investingnote.com. Purchase for the physical book shall be made via www.bpwlc.com.sg/contact-us, stating your name, mailing address, quantity to purchase. All payments shall be made upfront before the physical book is mailed out.
Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell out of the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.
Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.
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