FinanceMind
building financial freedomFinanceMind
building financial freedomMany people have likened stock investing to gambling and the stock exchange to casino. Here are some of the similarities and differences between stock investing and gambling.
Casino games have a house edge built into the games. For example, in roulette there are 37 numbers. If you bet $1 on one number and you win, you are paid $36. If you bet $1 on all the numbers, you will definitely win and get paid $36. But because you bet on all the numbers, the total stake is $37. You’ve actually lost $1. This is called the house edge.
The house edge in this case is 1/37 which is 2.7%. This means that every time you place a bet, the expected value of your returns (or investment) is 100% - 2.7% = 97.3%. If you play 1000 games at $1 each, then at the end of 1000 rounds, you’d be expected to have in your hands $973.
In stock investing, there are broker fees and commissions. You pay these irregardless of whether you make any gains on your investment. If you make gains, you’ll also have taxes to pay. Example, you have $1000 and you buy 1000 different stocks at $1 each. After 1 month, 500 stocks increase $0.50 and 500 reduce by $0.50. Then you decide to sell all the shares. (500 x $1.50) + (500 x $0.50) = $1,000. But you don’t get $1,000 because you still need to deduct for commission and taxes.
All these expenses could be likened to the casino house edge because they eat into your profits. It is therefore advisable to hold your stocks for the long-term.
For the majority of the people the winnings and losses from gambling activities are considered capital in nature. It is only considered income in nature if the individual makes a living by gambling.
Similarly, for the majority of us, gains and losses from buying and selling of stocks are considered capital in nature. It is only considered income in nature if the individual makes a living by frequently trading, such as a day trader.
Therefore, both activities are subjected to similar tax treatments.
When you place a bet on a casino game, you are actually buying a “chance or opportunity”. It is an intangible product.
When you invest in stocks, you are investing in the business. You are investing into a tangible product or business.
Gambling is a type of entertainment. Nobody in their right mind will use gambling as a means to a better financial future. Why? Because over the long-term, the casino always wins.
Investing in stock is a good way to build up your personal wealth. It is a great tool to offset inflation. Over the long-term, your investment will appreciate and at the same time you also earn dividend income from your stocks.
Your relationship with the casino is limited to the time your stake is on the table. If you bet “Banker” and the outcome is “Player”, you lose and your relationship stops there.
When you buy a stock, you build a long-term relationship with the business. Your relationship doesn’t end when the share price moves up by $1 or falls by $1. It ends only when you decide to sell it.
When you lose your stake in a casino game, your stake is gone. There is no way for you to recover your losses unless you bet more of your money.
When share prices fall, you still have your stock with you. The business still runs, unless the company files for liquidation. You can still hold on to your stock and wait for the market to recover. There’s a possibility for you to recover your losses without investing more money.
There is risk in gambling. There is also risk in stock investing. However, in stock investing, you can manage and minimize your risks. Some ways are hedging and structuring your portfolio with different types of stocks to match your risk appetite.
Gambling is a game of chance. No amount of skill (with the exception of card counting in blackjack) will tilt the odds into your favor.
However, in stock investing, if you do enough learn how to trade and research your stocks before you invest then you will fare better than the average investor. A wise investor certainly can use his knowledge and skills to tilt the odds in his favor.
In summary, a speculator who buys and sells stocks is treating the stock market as a casino. Examples are day traders and swing traders. For these people the stock market is just another place for them to place their bets.
On the other hand, a true investor will have a plan. They enter and exit the market based on the prospect of the stock over the long-term. This makes them less vulnerable to short-term fluctuations, hence reducing the gambling element.