If you’ve been around long enough, you have likely heard a story or two about a friend or family member who has lost a sizable chunk of their life’s savings on a bad investment. On the same token, similar stories prevail about people losing everything gambling on something like sports or in a casino.
This similarity in outcomes often begs the question: Is investing in stocks gambling?
Investing in stocks is not gambling. While there is definitely an element of luck involved and stock market returns are not guaranteed, proper research, risk management, and patience can make most people winners when investing in the stock market.
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Despite the evidence that smart investments in stocks is one of the best means of steadily building wealth, it still gets viewed as gambling by many people. This sentiment has been strengthened by the increased number of commission-free trading apps, such as Robinhood and TradeStation, which are known for their “casino-like” interface.
Throughout the rest of this article I am going to give a breakdown that simply explains why stock investing is not gambling.
Is Stock Investing the Same as Gambling?
Although it is possible to make money and lose money through gambling in the stock market, they are not the same.
Investing in the stock market is not gambling and should not be viewed that way as there are several strong points of distinction between the two.
Stock Investing Is Not Adversarial
This is probably the strongest reason and best method for demonstrating the difference between stock investing and gambling.
When investing in stocks, you are working with a company to help it succeed and grow its profits. Companies issue stock to help fund any number of important business functions, including:
- Research and development
- New product launches
When companies do this successfully, the investor is rewarded through an increasing share price, meaning that they could sell their shares for more than the purchase price and earn a profit.
It is also possible that an investment doesn’t go well though. If a company executes poorly, then both the company and investor could see the value of the stock diminish and therefor the investor could lose money.
Related Financial Geek Article: Are Stocks Just Luck? We Explain
Gambling is Adversarial
Gambling, on the other hand, is adversarial in nature. There is always a winner and there is always a loser.
If you win, well then the house loses; when the house wins though, you lose. In other words, no wealth is created for the betterment of all like in investing.
What makes things even worse is that with gambling – the house always stacks the odds slightly in their favor. This is known as the vig, which is often referred to as the fee for playing.
Because of the vig (vigorish), a 50/50 coin flip will still put the house ahead over time, so gamblers must win more than they lose to stay profitable. And for anyone here whose gambled before, staying profitable over time is a tall task when playing games of chance.
Opponents of stock investing traditionally argue that brokerage fees are essentially a form of the vig. However, commission-free trading apps, such as Robinhood, have basically made this argument irrelevant.
Stocks Generally Provide Some Form of Return
Gambling is typically an all-or-nothing proposition. When you place your bet, you either win and get paid off or lose your entire stake. Yes, some modern sports betting apps allow you to cash out bets early to mitigate losses, but when you place a bet on a roulette table or toss money into a poker pot, it only comes back to you if you win.
Stocks usually allow the investor to avoid losing everything. If new information arises that causes share price to drop, the investor can decide if they want to stick with the stock or sell their shares and recapture some of their initial investment.
In addition, some stocks pay dividends. A dividend is a cash payment, usually issued every quarter, to owners of certain stocks. Even when the share price is going down, dividend payments can help people earn value for their investment and provide investors with a great source of cash flow.
If you are someone who wanted to invest in stocks for the purpose of dividends, it’s important to note that not all stocks don’t pay dividends. In my article Do Stocks Always Pay Dividends I show you how to tell if a stock is a dividend paying stock or not.
Related Financial Geek Article: Non-Dividend Paying Stocks | Why Do People Invest in Them?
Stocks Have Unlimited Growth Potential
Another key difference between stocks and gambling is that gambling winnings are always going to be somewhat capped, while stocks on the other hand have a limitless earning potential.
Payouts on gambling winnings are capped at the proportional value to what the odds of winning are. Therefore, even the most long-shot jackpot, which will provide a handsome one-time payment, is probably not going to be a ticket to long-term wealth.
Stocks have no ceiling to what in theory they could reach. Investors who took a chance on a company like Amazon at $1.50 per share in 1997 have likely done much better than high-stake gamblers over the last 25 years, as the current share price of Amazon is over $3,300 today with no end in sight as the company continues to innovate and grow.
While success stories like Amazon are certainly the exception, it does help to demonstrate the key difference between investing and gambling.
Why Are Stocks Risky?
Even though investing in stocks is not gambling, luck can definitely play a part, and absorbing risk is part of the trade-off in investing for a potentially high reward in return. A company’s potential is no guarantee of future success, with the following factors seen as threats that could potentailly derail even the most well-run organizations:
- Government regulation
- Technological innovations
- Changing consumer attitudes
- Natural disasters, with climate change a current threat to many companies
- Pandemics (just look at what happened to market indexes during COVID-19)
While some of these risks are unavoidable, investors can usually mitigate these variables with proper research and insight into the company’s overall mission.
Which Stocks Require the Most Luck?
Small-cap stocks require the most luck to return a profit to an investor. Small-cap stocks are generally defined as any company with a market cap of less than $2 billion. Some defining characteristics of small-cap stocks include:
- Not yet profitable, with the path to profitability unclear
- In a new industry trying to address an uncertain market
- Hinging on a major breakthrough to spur their success
- Run by entrepreneurs who may or may not be experienced leading publicly-traded companies
- Often carry massive amounts of debt to fund operations, with stock issuance an attempt to mitigate some of the debt burdens
Because a lot has to go right for a small-cap company to achieve profitability and stock growth, investors stand a real chance of losing everything when loading up too heavily on small cap stocks. However, if the company survives these early stages, the reward is limitless (see Amazon above), which often makes it seem like investors “hit the jackpot.”
So there you have it folks!
Although there is certainly risk and an element of luck involved in the stock market, let’s get one thing crystal clear, investing in stocks is NOT the same as gambling.
Thanks for reading.