Monday, October 14, 2013

Gambling and the Stock Market

When you talk to some people about investing, they compare buying stocks with a trip to Las Vegas.  This is understandable as huge dips in the stock market always make the news, whereas a gentle rise over time or even a large surge gets less attention.  Looking at investing and gambling over the long run shows one significant difference.

Gambling, on average, is a losing proposition.  Most lotteries are set up to pay out about half their revenue.  Buy a pick-3 ticket for $1 and get a 1 in 1000 chance to win $500.  Those are terrible odds.  You know this when you hear the states boast about how much lottery funds contributed to schools or property tax relief or another chosen cause.  That funding comes from the dollars of the losers who far outnumber winners.

At a casino lay down a dollar on a roulette number and win $35 if you happen to choose the right number out of 37 or 38 possibilities.  Those odds are better than the lottery, but over the long term the house keeps a few cents for every dollar bet.  Those pennies add up quickly and pay for those big, impressive buildings.  Slot machines pay a little to keep you playing and a large jackpot just often enough to keep everyone hoping, but over the long term the casino always wins.  On average gambling is a losing proposition.

The stock market does have some wild swings and looks like a gamble, but the difference between traders and investors is important.  Traders play the market trying to anticipate these swings.  Investors pick a stock or, less risky, a diversified fund and stick with it.  Investors are not as exposed to wild swings, because they are patient and ride out the peaks and valleys.  A good example (not a recommendation) would be the Vanguard Life Strategy Fund, which is very diversified – in fact it’s a fund made up of other funds.  Anyone investing $1000 in January 2003 would have around $1700 by now.  That includes all the scary economic problems over the last 10 years.  Over its 19-year history, it has yielded over 7% per year on average.  That’s so much better than money in a savings account or CD.  Of course, during that time anyone who tried to time the market, acting like a trader by buying and selling, could have gotten burned as badly as a Las Vegas gambler, but the history of positive gains is similar for almost any diversified fund from a reputable company.  They are easy to look up on line.

Now past performance does not guarantee future results, as they always say, but unlike gambling, investing – real investing and not trading and timing – has not been on average a losing proposition.  There is still risk, and emergency funds do not belong in stocks or any other volatile investment, but over the long term the stock market differs in this important way from gambling.  If the comparison to gambling has worried you in the past, it might be interesting to do some research or talk to a trusted advisor.

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