When we invest in a stock, we are buying a tiny percentage of a business. We are an owner. The more long-term your investment horizon, the more of an owner you are. And the inverse is true as well. The shorter your investment time frame, the more you are gambling.
If you are betting on a horse race, that takes a few minutes. A poker game can last a few hours. A day trader might hold a position for a day or two, maybe even a week. Someone who buys a put or a call is speculating on what will happen in a couple of months. A person who puts a coin in a slot machine is relying 100% on luck, and will get the results in seconds. A Warren Buffett investment might be smart or it might be stupid -- we'll all find out in a decade.
Short-term investing is about luck -- unknowable and outside your control. Long-term investing is about skill -- and honing your skills can make you rich.
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Two ways investing is like gambling
Suppose Ann bets $5,000 on a horse race, Betty gambles $5,000 at the poker table, and Cindy invests $5,000 in a biotech stock. Is it possible that Ann wins $10,000 and Betty wins $20,000? Yes. And it's also possible that Cindy loses all her money.
Investing in stocks means you are risking your money. That's one way investing is very much like gambling -- you might get richer, or poorer, and in the short term anything can happen.
Because there's an element of risk in stock picking, assessment of risk is one of the most important skills an investor can acquire. This is a gambling skillset as well. You are "figuring out the odds."
In gambling, like investing, there are some aspects that are outside your knowledge. You don't know what the future holds, for instance. So surprising things will happen. In both gambling and investing, you can lose money. And in both gambling and investing, you want to try to calculate the odds or probabilities so you can avoid loss and win money.
In investing, your upside is unlimited
If you bet $1,000 on Secretariat, and the odds are set at 2 to 1, what's the downside? You can lose $1,000. What's the upside? You can win $2,000. Your downside is set by the amount that you bet, and your upside is set by the bookmaker. What if Secretariat really, really wins? Doesn't matter. All you can win is $2,000. Your bet is over and we're done.
Or suppose you sit down at a poker table with $1,000, and four friends join you with $1,000 each. What can you lose? $1,000. What's your highest possible upside? You can walk away with $5,000. That's all the money on the table. Your downside is limited, but your upside is limited, too.
Now suppose you buy $1,000 worth of Amazon shares. What can you lose? You can lose $1,000. Your downside is limited by the amount that you risk.
What's the upside? It's unlimited. There are no defined limits to how high a stock can go. It can double, triple, quadruple. It can go up 10,000%. And then go up 10,000% again. Jeff Bezos doesn't know how high Amazon can go. Only God knows. The rest of us are guessing.
So buying a stock is similar to gambling, in that you are risking your money, and you might lose all of it. That's why figuring out the odds of success is very important. But buying a stock is a very smart way to risk your money. Your upside is unlimited by human hands.
What about shorting a stock? It's actually worse than gambling. It's the flip side of buying a stock. For a short, your downside is unlimited. You can lose an infinite amount of money. That's why the bankers cut you off at a certain point.
Smart gamblers invest in stocks
A stock has an unlimited upside and a finite downside. All you can lose is the amount you invest. What you might gain is unlimited. So the stock market is by far a better place to risk your money than any gambling den. The odds are better, and the ultimate payout is greater.
There's more. Stocks reward patient, long-term investors. What happens is that over time your winners will continue to win, and your gains will go up and up. So while the market is risky in the short term -- like a casino -- over the long term the effects of chance or luck are downsized, and what really matters are your skills and your thinking.
Finally, even if you lose money in the stock market, you are doing humanity a service by investing. For instance, Cindy, the hapless biotech investor who lost $5,000, actually helped the world by funding scientific research. Knowledge is gained, and lives are saved. (Plus she can take the investing loss off her taxes.)
The stock market is where true wealth is created. So don't be afraid to invest. Understand the risks, think about them, and jump in.
