A lot of us wait all year for football season to begin. It means fall weather, tailgating and cheering on your team. Every year, I hope my Tar Heels rise to the top. While they have not gotten all the W’s I’d hoped for so far, I go into every game “knowing” they will come away with a victory. But the truth is, I can’t know that for sure — nor can any other sports fan out there. Which leads to the question of whether sports betting is a risk you should take. And this is coming from someone who has built their career “betting” on the stock market.
Since my election, I’ve tried to educate the public on some of the most important basics in financial literacy. This month, I wanted to dedicate this newsletter to a small distinction in finance, which is, in actuality, an enormous difference.
While I must admit there are some similarities between investing and gambling — the role of chance being the central one — making this comparison is like saying that competitive eating and competitive swimming are the same thing. True, they are both competitions, and you could potentially win fame and riches doing them. But I think we’d all agree that the long-term implications for your health are quite different!
It is the same with investing and gambling, and it is really important you don’t step into the investing world with a gambler’s mindset. The central difference between the two is felt in the long term. If you can be an average investor over long periods of time (remember — passive, or index, investing requires little skill, and is an above-average strategy over time), you end up better off. If you are an average gambler over time, you end up no better off — and if there is a casino or other intermediary involved, you end up broke. In both investing and gambling, of course, skill matters — but in gambling you are fighting a headwind, while in investing you have a tailwind, and that difference is crucial.
To illustrate the point, let’s dissect how you build wealth through owning common stocks. If you buy a share of a company, you are buying a share of all the profits that company makes in the future. That means there are three ways you can win:
- Your share of earnings: Each year, the profits of the company will be divided up, and the company will either send them to you as a payment (a dividend), increase your share of ownership in the company (this is what a stock buyback is — it reduces the number of shares of the company outstanding, so you own more!), or re-invest those profits to increase next year’s profits even faster.
- Growth of the company’s earnings: Almost every company has plans to increase its profitability next year, and you benefit from these efforts as earnings grow over time.
- Changes in valuation of the company: While this is the most unreliable way to win, we do see a long-term uptrend in the valuation of common stocks. This is independent of the earnings growth mentioned above. The market over time has consistently paid more for every dollar of earnings, which has provided a tailwind for a long time for investors. It is possible that this trend could reverse of course, but that’s a much longer topic for discussion.
In gambling, there is only one way to win. And that is for your opponent to lose. While investing is what is called a positive-sum activity over time, gambling is zero-sum. Someone has to lose for you to win, and casinos set up the games so that they aren’t the loser… There’s a reason for the saying, “The House Always Wins!”
