- The Wealth Expedition
- Posts
- Smart Investing Is Not Gambling
Smart Investing Is Not Gambling
I've heard past clients describe investing as gambling. And I've had others who acted like gamblers on the stock market. But smart investing is nothing like gambling. Here's why.
Daniel Lancaster
October 28, 2024
Our weekly newsletter features the following sections:
First time reading? Subscribe for weekly content here.
“There is no more fatal blunderer than he who consumes the greater part of his life getting his living.”
-Life Without Principle by Henry David Thoreau
NEWS
What Happened Last Week
The IRS announced the 2025 tax brackets, which are rising by about 2.8% apiece from 2024.
US retail sales were positive for their third month in a row, the longest streak of the year.
The International Monetary Fund (IMF) predicts that global headline inflation will be below its 20-year average by end of next year.
Investors’ feelings of optimism have cooled slightly over the last week, according to the AAII Investor Sentiment Survey and Fear and Greed Index.
How I See It
The outlook for goods manufacturing has been a bit weak since June. But good news this week from retail sales appears to support that US consumers are maintaining demand for purchasing material goods.
What that means for the stock market? Not much. The goods industry means less to the overall economy than the services industry in the US. And the services industry appears to remain in growth mode.
Remember, markets don’t need great news to continue growing.
They usually just need boring, status quo type activity.
The IMF has echoed the optimism that many investors feel, confirming a major milestone in the fight against inflation. But now that high inflation appears to be mostly behind us, they raised awareness of the threats they perceive to global growth in the years ahead: geopolitical conflict, trade wars, lower migration (or birth rate), and tightening monetary conditions.
But none of these necessarily point toward a bear market next year. These are well-known, generalized risk factors.
And stock markets move when there is a difference between expectations and reality.
So we know what potential realities might be. Now let’s look at expectations.
Expectations fell slightly this past week, as we saw optimism moderate somewhat among investors. There’s still enough doubt and caution in the minds of investors to keep the stock market healthy.
That doesn’t mean there won’t be market pullbacks or even a correction (down 10%-20%) at some point in the next twelve months. But these types of market movements happen quickly, and often for any reason, even if it’s not a good reason. They are psychologically driven more than fundamentally driven.
Signs don’t appear to be pointing toward an impending bear market, however, which is the long and deep downturn.
PARADIGM SHIFT
Smart Investing Is Not Gambling
American author Henry David Thoreau lived through the California gold rush of 1848-1852.
This spectacle led him to criticize the frenzied thinking that had overtaken many Americans at that time:
“The rush to California, for instance, and the attitude, not merely of merchants, but of philosophers and prophets, so called, in relation to it, reflect the greatest disgrace on mankind. That so many are ready to live by luck, and so get the means of commanding the labor of others less lucky, without contributing any value to society! And that is called enterprise! I know of no more startling development of the immorality of trade…Did God direct us so to get our living, digging where we never planted — and He would, perchance, reward us with lumps of gold?”
In essence, this was a gambling mindset that took hold of the population. When there was the slightest hope of getting something for nothing, people tore up the ground with the hope that they might be among the lucky few.
I’ve been asked by clients in the past: “Isn’t investing just gambling?”
The answer is a resounding no.
Here are the two reasons.
Gambling always involves betting against the odds. One is playing with luck and testing it. The more one gambles, the more likely they are to end up with a net loss.
Gambling offers a limited benefit to society by offering entertainment and (typically false) hope. But the net effect could be argued as a net negative effect on society.
Smart, diversified investing is completely the other way around.
Once you’ve diversified away the non-systematic risk (company-specific risk), you can invest long-term with the odds extremely strong in your favor.
The longer you invest, the more likely you are to make a lot of money.
Investing also provides an absolutely crucial benefit to society. It places capital in the hands of companies that are deemed most likely to meet the wants and needs of individuals in the years ahead. Rather than letting your money lie unused in a bank account, you’re essentially employing it to be used for innumerable valuable purposes that serve your fellow human beings.
Smart investing keeps the economy moving forward and makes the world a better place for everyone. And you directly reap the benefits of it over the years!
FINANCIAL TOOL
Prospect Theory
Since we’ve hit on the subject of gold prospectors, let’s talk about Prospect Theory!
There are two main propositions of Prospect Theory as it applies to finance:
Investors emotionally feel the pain of loss about 2.5 times greater than they feel the pleasure of an equivalent gain.
Investors generally underestimate outcomes with a high likelihood, and they overestimate outcomes with a low likelihood.
It’s important for you to know this about psychology, because this weakness is the cause of so much lost wealth due to irrational investor behavior.
Take note: the emotional pain of experiencing a loss is significantly higher than the pleasure of an equivalent gain. So naturally, investors experience fear of loss more intensely than they feel desire for gain.
If Investor A starts with $100,000 and his portfolio falls by 20% to $80,000, he is far more likely to make emotional trading decisions to “stop the bleeding” than if he’d started with $67,000 and grown by about 20% to $80,000.
In fact, even if he experiences a 20% increase, he’s likely to still be worried about loss. So whether he gains or loses, the temptation remains to fear loss.
This results in the observable fact that investors, by and large, underperform markets by buying high and selling low.
Prospect Theory also proposes that investors don’t estimate outcomes properly. For example, a miner in the gold rush era definitely overestimated the chance of acquiring riches. Yet the gold frenzy swept the nation nonetheless. The same goes for gamblers, who by definition overestimate the chance of success.
Then there are those who underestimate the higher likelihood events, such as achieving a high long-term average market return even if they ride through bear markets and take no action at all.
Knowing these tendencies of human nature can help you identify these thoughts and feelings when they arise in your own conscience, and you can more effectively guard against the temptation to act on these irrational biases and misjudgments.
HERE’S HOW I CAN HELP
FUTURE RESOURCES ARE IN THE WORKS!
You will have access to in-depth digital courses in the very near future.
The first major course will reveal how to create a massive surplus monthly cash flow that perpetually increases through a combination of budgeting, increasing earning potential and investing.
We will be focused on comprehensive wealth which values not only money but also time and freedom.
In the meantime, here is a book I’ve read multiple times! It’s a short and pleasant read by Henry David Thoreau, published in 1863.
This book won’t teach you to be rich in a material sense. But it does an excellent job of examining what is truly worth working for. What should work be? Why should we do it? What should be the end result of it? And how do we awaken to the rich life all around us?
If this sounds interesting, give it a read and let me know what you think!
Life Without Principle by Henry David Thoreau
This post contains affiliate links, which means I may earn a commission if you make a purchase through these links at no additional cost to you. Thank you for your support!
I’d love to hear from you. Let me know what you’d like to see in upcoming newsletters, articles, or a digital course at Contact Us - The Wealth Expedition.