Is the Stock Market Gambling?
Many skeptics of stock market investing claim that the volatility and potential for loss mean that investing in stocks is akin to gambling. In reality, stock investing can be considered gambling in certain scenarios, while fundamental, long-term investing would not be.
What would be considered gambling?
To understand whether the stock market is gambling, let’s first look at two clear cut examples of gambling: Sports betting. When placing a sports bet, what is won (or lost) by the bettor is most (or made) by the “bookie”, or person taking the bet. This would be known as a zero-sum game as no incremental value is generated. Additionally, there are significant costs for the bettor. Let’s say you want to bet on the Rams to beat the Patriots in the super bowl and the “line” in -110. You would lay out $110. If the Rams win, you win $100. If they lose, you lose $110. Since most bettors have a minimal discernible advantage in choosing games, we’ll assume the chances of winning are 50%. The “expected value” of this is bet is 50% * $100 - 50% * $110 = -$5. The negative $5 means that this particular bet is expected to lose $5 “on average.” With one wager, it would be impossible to lose $5, but with the expected value you should think about it as if you placed the bet several times. So if you placed this bet 100 times, you would be expected to lose $500.
Let’s take another example of concrete gambling, the casino. The odds in each game in the casino favor the “house”, or the casino. For example, for every dollar wagered in the blackjack, the “house” is expected to win about 3 cents. So for every million dollars bet in blackjack, the house is expected to win $30,000. Some bettors will win, but most on average will lose. If you don’t believe it, think about how casinos make money. The drinks are free, they don’t sell merchandise, and you don’t pay for entry. Yet many of them turn large profits and build state-of-the-art facilities.
Why is the stock market different?
Unlike gambling, investing in the stock market has a positive expected value, or an expectation that on average you will make money. When you purchase a high-quality stock, you are expected to make money over time, either through dividends (distributions of profits to owners), capital appreciation (increases value), or both. As the company generates cash flows and grows, the value of the company increases and each share is worth more. Even if the company doesn't grow its profitability, the profit it earns is shared with its stockholders and a positive return is generated. Investing in stocks is not a zero-sum game and has a positive expected value.
Does this mean that you'll make money on every stock you purchase every time? Absolutely not. Some stocks will rise and others will fall. Over some periods, stocks will rise (a bull market, or period of rising stocks), and other times stocks will fall (a bear market is defined as a drop of 20% or more from highs, and a correction is a 10% drop). However, if you own a diversified basket of high-quality stocks, such as those in the S&P 500 or Dow Jones Industrial Average, over time you will earn positive returns.
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