Investing Is Like Gambling!

Markus Muhs - Dec 24, 2018

There are some real analogies to be made between investing and gambling.

I still remember the first time I made an actual investment decision for myself. It was fall of 1999 and my father had already started a mutual fund account in trust for me with his advisor years earlier, putting a little bit per month into a boring old large-cap global fund. Seeing the types of returns being made those days on technology and healthcare stocks I - now an 18-year-old adult - took ownership of the account and asked to shift it all into a pair of high flying technology and health science funds. 

Thankfully the advisor counseled me on risk, to which I responded "I like to gamble!" to which he retorted "Investing is not gambling." We ended up putting half the account into the two new funds, and if you know anything about market history you guessed right: those two funds lost most of their value before I finally dumped them in the mid-2000s. My first lesson on behavioural investing.

In the time since then I'd also kind of gotten into casino table games. Not so much anymore, but there was a time span while I was attending Northeastern when some buddies and I made regular drives down to Foxwoods and Mohegan Sun in Connecticut (sometimes both in the same night), thinking we knew how to count cards or something (we didn't, but at around the same time, unbeknownst to us, some nerds at a technical institute on the other side of the Charles River were doing it for real). Anyway, contrary to what my advisor was telling me, I was seeing some real analogies between gambling and investing.

A couple of table games were practically made to appeal to stockbrokers; Roulette and Craps.


So weird to see this complex pop up in the middle of nowhere as you're driving the New England countryside (photo from Wikimedia Commons)

I never played much Roulette, as I consider it to be too simple and random. It's very easy to make investing analogies with the game though: you have a bunch of numbers laid out on the board that you can bet on; these are individual stocks. Bet all your money on one or buy a diversified basket. Then you can buy funds: the black fund, the red one, even numbers, odd numbers, first third, second third, third third, etc. I forget what all the exact odds are, but the casino maintains a slight edge on the game by having either one or two green numbers (0 and 00) on the wheel, making a loser of you whether you bet on black or red.

Craps is a far more interesting game, with more trading analogies. It'd take way too much time to fully explain this game, but essentially there are also numbers on the board to bet on and instead of a roulette wheel there are a pair of dice that each player takes turns rolling. Better odds, but lower payouts, are to be had on the pass lines and side sections, where for the most part you're betting on the sum of each roll. Consider these the blue-chip stocks. When the game is "on", you can bet on these numbers and collect dividends from them, or press your bets (a "dividend reinvestment plan") at the risk of losing everything when someone rolls a 7. Higher payouts, but worse odds, are to be had in the Hardways and "one roll bets", where the combination of the dice matters. These are more small-cap, speculative investments.

What also makes Craps really analogous to investing is how you can actually "short-sell" the table and bet against everyone else. Unlike stock trading, short-selling the Craps table actually has better odds, but just as when shorting stocks, this makes you a jerk and everyone will hate you.


Source: Wikimedia Commons

The avid table game players know the ins and outs of each game, including the precise odds on each bet. They'll even know the effect that tiny manipulations by the casino on the game rules or bet limits have on those odds. These players will generally flock to those games that have the best odds, and concentrate on making the "smarter" bets.

Overall though, casinos know how to make money. The best odds you'll get in any game are slightly less than 50%, so if you keep playing the same bet in the same game over and over again ad infinitum you'll eventually lose all your money. It's only because of timing that we may leave a casino happy with a wad of cash or empty-handed. Your win/loss record, while it might be 49/51 long-term, might have occurred during a shorter streak of time that contained more wins or more losses.

Now, imagine if the casino game out with a new game. It's an especially boring card game where they simply provide a deck of 100 shuffled cards and draw the top card for you. Some cards are red, some are green. You make a bet on each hand and if it's green you get paid 1:1, if it's red you lose. Nothing more to it; super boring.

Here's the kicker though: 65 of the cards in the deck are green and 35 are red. You get the same odds regardless.

Such a game would never exist because the casino would quickly go broke. Every avid table game player would be lining up to play this game and would be simply betting hand after hand, never stopping. It would be boring as heck but the player would over time get richer and richer.

The game I'm describing literally is the stock market and roughly its odds over the past 100 or so years that any given year the overall markets will be positive or negative. If you could play such a game (YOU CAN!) wouldn't you just keep hitting over and over and over again? You'd lose your bet occasionally, but you'd know that by betting again and again eventually the wins will outnumber the losses around 2 to 1. All it takes is time. If someone told you you could increase your winnings by sitting out occasional hands or betting heavier on others, you'd tell that person to take a hike, because it makes no difference over the long term and this is all pretty random and unpredictable anyway.

So that's where I'll end this blog post, with a glimpse into my own past (it didn't take too many visits to the casino to learn that I was losing more often than winning) and an analogy that hopefully brings comfort when it comes to looking at the stock markets (in that they're much better odds than actual gambling!).

It's just before Christmas as I write this and the S&P 500 just had its worst week in 10 years. I've almost forgotten what it looks like to see a market finish the day in the positive. I imagine that for a new investor who just got started recently it's literally like plopping down $100 at the Craps table and seeing every roller seven-out after the come out roll 5 times in a row. This is not quite literally a crap-shoot though, and remember that the win-loss record will eventually revert to its long-term average.

 

If you have any questions, or want a quick tutorial on Craps, don't hesitate to drop me a line.

 

Markus Muhs, CFP, CIM 

 

Title photo courtesy Pixabay