"Investing in the stock market is just like gambling." You've likely heard the comparison before. While I generally disagree with that statement, I do believe that investing in certain parts of the market without a plan can result in the same dynamic as gambling. Are you ready to make a bet?
Let's take a look at the similarities between investing and gambling, the key differences, and why it’s so important to distinguish your objective.
Investing and gambling are both based on risk and choice. In both cases, you are risking your capital based on hopes of future profit, with emotions often leading to poor decisions. When investing in stocks, you have choices of different companies and ways to leverage the potential payout. With gambling, you have a list of bets and odds available. But there are several noteworthy differences to distinguish the two:
- Over time, the odds of profiting and compounding will be in your favor as an investor. Long-term returns are generally positive and less volatile as time passes. Typically, the odds are stacked against gamblers.
- Investors emphasize mitigating risk. Investors achieve this in several different ways, such as diversification, asset allocation, and hedging.
- Gambling is typically short-lived while investing can last a lifetime.
When thinking about the stock market, smart money views it as a long-term strategy to build wealth throughout a lifetime. Invest with a plan, conduct research, diversify appropriately, and rebalance. The dumb money views it as an easy way to make a quick buck, lacking the same planning, diligence, and patience that allow gains to compound over time.
Gambling in the stock market is not a recent phenomenon. Day traders have been in existence since well before the coronavirus pandemic. The pandemic only accelerated the use of the stock market as a gambling tool.
When the initial shutdowns took place, sports came to a virtual halt across the globe and casinos closed their doors. This was a problematic situation for avid gamblers, who discovered they could day trade stocks to fill the void.
To help fuel the fire, many Americans received stimulus checks soon after finding their new money-making hobby. This combination led to a surge in speculative trading by retail investors. Hot stock tips, high-risk options, and margin trading (using borrowed money) have become very popular for new entrants in the stock trading arena. So far, they have been a fortunate group getting into stocks at the right time.
Pro sports and casinos shut down just as the market experienced its fastest crash in history, down 35% in March 2020. Since that low point in March, the S&P 500 is up around 70%. The Russell 2000, consisting of smaller, higher-risk companies, has doubled since its' March 2020 lows.
Stocks have been gaining since the pandemic lows, so much that they are sparking an encouraging yet potentially scary development: Everyone wants to be a stock trader! This is encouraging in the thought/hope that people are looking to invest their money by conducting due diligence and selecting stocks they think will help deliver long-term results.
The scary side is that many retail traders have demonstrated an insatiable appetite for risk, regardless of the businesses' profitability or overall health into which they are dumping money.
This side of the story is still underway but has already culminated in one of the most bizarre developments we've witnessed in a long time.
If you've been reading headlines or watching the news recently, you likely heard about GameStop and other struggling businesses experiencing wild swings in their stock prices. This quickly turned into a story of individual investors/traders betting against the professionals.
The individual investors grouped to drive GameStop's price up in a "short squeeze" against the professionals, initially leaving a few hedge funds in a state of shock and with heavy losses. It was relatively short-lived. Read More: GameStop Mania
While some made profits, many small individual investors were caught holding the bag, as the drive up "to the moon" was unsustainable, and the stock price dropped back to earth just as quickly. This short-term perspective likely caused many traders to lose money.
“Don’t confuse brains with a bull market”
Hopefully, the flow of individual investors over the past year is here to stay. I caution the euphoric subset of those entrants to the market with a simple yet powerful quote from Humphrey B. Neill, "Don't confuse brains with a bull market."
In a raging bull market, you may be able to get away with limitless risk and speculative trading, but only briefly. But when the bull market ends and fundamentals come into play, you don't want to be caught holding the bag without a long-term strategy. Educate yourself, understand the risks involved, and learn to invest instead of gamble.
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Please remember that past performance may not be indicative of future results. Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.
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