The Fribble, Foolish Gambling


Foolish Gambling

April 03, 1997

I was at the local home and garden show when I saw the oddest thing in a financial services company's booth. It wasn't the fact that an investment company was at the show; there were at least ten. All were figuring that if you can afford a house, you can afford to invest. No, the odd (not Foolish) thing was that they were sponsoring a contest where you had a chance at winning 50 lottery tickets if you would give them your name and number.

The reason that it struck me was that, even though investing often uses gambling language, this was the first time that I had seen a financial services company blur the distinction. Usually investments are presented on a higher plane than gambling. The state government blurs the distinction all the time to drag investing down to the level of the lottery. One commercial here goes along the lines of, 'Saving for a rainy day takes too long; you could win $50,000 instantly if you play the lottery.'

It is to the government's advantage to do this. Many people agree with them that there is no difference between investing and gambling. If you read the papers, especially concerning the privatization of Social Security, you will find many examples of where the editorial writers who compare the change to the spin of a roulette wheel. This happens because most editorialists, along with many in the general public, are guilty of innumeracy. Webster's defines the innumerate as someone who is ignorant of mathematics and the scientific approach. Innumerate people will prefer a 10% raise in a period of 15% inflation over a 5% raise in a period of 3% inflation. Unfortunately, being innumerate does not prevent a person from having opinions or writing them in a paper. Fortunately, most financial reporters know about concepts such as compound interest or they find that their audience quickly educates them. Fools remember when the tulip hysteria was placed in Denmark.

But how does going the other way, equating investing with gambling, make business sense? Widespread innumeracy, strangely enough, is what the financial services people must have been betting on. If people look favorably on the lottery, then they will look favorably on investing. Their marketing gooroos must have come up with the idea that to bring in a new wave of investors, they must go after the betting crowd.

So why are investing and gambling linked? Because there is an element of uncertainty in both. There are no guarantees that the Dogs of the Dow will continue to perform as they have. A lot of people hate that because they have a low tolerance for ambiguity. They want investing to be a black or white choice. They want safe, predictable, linear returns. An entire industry has sprung up to cater to this need for predictability. It is called banking and its profits are in the billions.

Fear of uncertainty and innumeracy are synergistic. Most people cannot do the odds. What is a better deal over a year? A 100% safe return with 5% interest or a 90% safe return with a 20% return. For the first deal, your return will be 5%. For the second, your return will be 8%. Say you invest $1000 10 times. Your interest for the 9 successful deals will be 9000 x .2 or 1800. Subtract the 1000 you lost on the 10th deal and you get a $800 return on your original $10,000 for 8%. If the safety dropped to 80%, you would have lost $400 or -4%.

If you try to discuss this in polite society, a lot of people will tune you out. They cannot deal with the uncertainty and so keep their money in the bank (another synonym for a sure thing). On hearing the 10% chance of losing, they translate it to 100%. Then they use the total loss as a reason to ignore what you are saying. As Fools, we are willing to accept ambiguity, even welcome it. Most importantly, a Fool must be willing to crunch the numbers to reduce the uncertainty. We may not always be right but we can increase our odds of placing a correct bet by doing the math.

Remember that, buried beneath all the talk of betting, risk and odds, are two simple numbers that the state does not want you to think about. The lottery returns 50 cents on the dollar while the stock market returns 110 cents. Any Fool can see which is the best.