Why investing is not gambling

by Cliff D'Arcy on 10 October 2010  |  4 comments
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We explain why stock markets are not the same as casinos...

It’s often said - quite wrongly, in my view - that stock markets are global casinos and shares aren’t much better than lottery tickets.

Shares are not lottery tickets

However, in the words of celebrated US fund manager Peter Lynch, “Although it's easy to forget sometimes, a share is not a lottery ticket... it's part-ownership of a business.” So, buying shares isn’t about gambling. Your goal should be to buy as big a slice as you can of the profits to be made by British (and foreign) companies.

If you choose to own successful, well-run businesses, then your shares should rise in value in the years to come. What’s more, while you wait for these capital gains, you can earn dividends: the income paid by (many, but not all) companies to their owners.

Thus, with shares, your return is made up of two things: capital gains and dividends (which can be reinvested to produce even higher capital gains). In the really long run, shares prove their worth: since 1899, the UK stock market has produced an average return (before inflation) of 11% a year with dividends reinvested.

Why gambling sucks

The big problem with gambling is that it comes with a ‘negative expectation’ - an inbuilt bias towards losing in favour of the provider. In other words, for every £100 wagered, you’re likely to get back considerably less than £100. Of course, you may strike it lucky and win back more than you bet but, overall, bookmakers and casinos make a good living from losing punters.

For example, the National Lottery is a very poor gamble indeed. This is because less than half of ticket sales is returned as prizes. With such a high negative expectation, the Lotto and scratchcards take in £5 billion a year, but pay out less than £2.5 billion. That’s an awful return for everyone except a few jammy prize-winners!

Likewise, the odds are against punters who choose to play in casinos. The basic negative expectation - the ‘house edge’ - for card game Blackjack (broadly similar to ‘21’ or ‘Pontoon’) is 5.9%. So, put £100 across the green baize, and employing the same strategy as dealers follow, you should lose an average of £5.90.

However, by employing various strategies, such ‘card counting’ and other statistical techniques, expert players can turn blackjack into a game with a small positive expectation. That said, using these methods will soon see you banned from casinos, so they’re of little help to the casual player.

Despite its supposedly glamorous image (à la James Bond), the roulette wheel is actually a pretty poor gamble. Without any way to influence or affect the odds, roulette players in the UK face a house edge of around 1.35% on even-money bets and 2.7% on all other bets. There is no valid technique to beat these odds, so anyone who claims to have a winning roulette system is talking hogwash!

In horse racing, the bookie’s in-build advantage varies, but most major horse-racing events have an ‘over-round’ of 130%. In other words, for every £130 bet, the bookies expect to pay out £100. This over-round equates to a negative expectation of 23%, turning £100 into £77. Of course, some racing enthusiasts and insiders do make money from betting on the gee-gees, but they are few and far between.

For sports betting, a typical over-round would be somewhere in the region of 108%. In other words, bookies take bets of £108 expecting to pay back £100. This is a negative expectation of 7.4%. Then again, over-rounds for both horse racing and sports betting can be significantly reduced by using online odds-comparison services or betting exchanges such as Betfair.

Recent question on this topic

• daveg asks:

  I have been advised to invest in gold and defensive stocks and ditch bank, housebuilding and general retailers shares. What do you think of that advi

  • 
    JoeEasedale answered "Bank Housebuilding and general retailing are not the best sectors to be in perhaps, but the time to..."
  • 
    daveg answered "Joe - I am approaching retirement and want to have a balanced portfolio with medium to low..."
  • Read more answers

Finally, Premium Bonds are in no way a true gamble, because you never lose your capital. Indeed, the current interest rate paid by premium bonds is 1.5%, producing a monthly prize fund which was over £52 million in August 2010. Of course, you could be unlucky and never win a single prize, but the fact remains that, overall, Premium Bonds produce a positive expectation for their 23 million owners.

Shares beat betting

In summary, although there is no guarantee of a positive return from shares, at least there’s no certainty of loss in aggregate, as happens in gambling. That’s the primary reason why investing should never be confused with gambling.

Even so, you should heed these wise words from veteran trader Bob Dinda, “Select [shares] the way porcupines make love - very carefully.”

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