Okay, how many times have you heard, "The stock market is just a big gamble"?
With the wild gyrations that we see every day in the markets, the idea that
"it's all a crap shoot" can be pretty convincing. Well, Fools, I am here
to try and shed some light on all this "gambling" talk. I think it's both
very helpful and very educational, when something is misunderstood, to define
the terms used to describe it. In that spirit, I offer the following statistical
definitions of 1) Gambling, 2) Speculation, and 3) Investing. It is very
important to understand the intrinsic differences between the three so that
you can have complete confidence in Investing your hard earned money. Here
goes. . .
1) Gambling---To understand gambling, you need to think in terms of total
return on each dollar you put up as capital. Statistically speaking, for
each dollar that you "risk" in gambling, by definition you MUST expect to
get LESS than that one dollar back in return. You may ask " Why in the world
would I gamble if I thought that I would get less back?" Good question. Let's
use the following examples. In the lottery, how much of all the pooled money
actually gets paid out? Well, for every $1, only about $0.44 goes into the
pot. Half goes straight into the coffers of the state, and about $0.06 on
the dollar goes to administrative costs. So, for every dollar that you put
up, the most you can possible get in return is $.44. I know it sounds confusing,
but think about it. Theoretically, on the whole, only 44% goes into the pot,
so it's impossible to get your full dollar back. Another short example. .
. in the casino, the house always has the odds right? Of course. On the roulette
table, if you bet black or red, you think it's a 50-50 shot, right? Nope.
Remember the green 0 and 00?? You don't have an equal chance to get that
whole dollar back, because logic dictates that at some point green will come
up.
CONCLUSION : In gambling, the odds are with the house. So, for every dollar
that you put up, you must EXPECT to get less than that one dollar back.
2) Speculating---First, for the sake of this Fribble, let's define what we
mean by "speculative" markets. Speculative markets are the Futures markets,
the Options markets, and the commodities markets. In a minute, you'll see
why these markets fall under the speculative "umbrella". Going back to our
"dollar" example, we said that in gambling, for every dollar you put up,
you have to expect to get less than that dollar back. Well, in a speculation,
for every dollar that you put up, you expect to get that dollar back, but
no more, and no less. Here's why: (let's use the options market as our example).
When you buy an option, someone sells it to you, right? For every dollar
that your option goes up, you make a dollar and the person who sold it to
you loses a dollar. Again, if you make a dollar, someone loses a dollar.
No money is ever created. There is no growth. This is what real fancy academic
types call a "zero-sum gain." Basically, it means that net-net, there is
no wealth created, thus "zero-sum." In order for you to win, someone has
to lose an amount EXACTLY equal to the amount you win. That is why for every
dollar you "put up," you can only expect to get that one dollar back, no
more, no less.
CONCLUSION: Speculative markets are "zero-sum gains" markets and as such,
no wealth is ever created, just moved from one hand to the other. Therefore,
for each dollar used to speculate, that dollar and only that dollar can be
returned.
Now. . .
3) Investing---For every dollar that you invest, you fully expect to get
MORE than that one dollar back. Why? Well. . . that gets a little hairy,
but I'll try and explain. The first and easiest reason to understand is
historical performance. The stock market over a long enough period of time,
has always gone up. The real question is "WHY." To answer that we must make
an assumption. We must, as difficult as it is to do, assume that people are,
on the whole, . . . er. . . uh. . . RATIONAL. As inefficient as the markets
may seem to be, we must assume that in the long run, the numbers always win
out and that all available information is factored into decisions about stock
prices. (Sometimes, judging by my portfolio, it takes a VERY long time!!!)
So, people as a whole are rational. We must also assume that people, by their
very nature, are CONSUMERS. Why do you get up and go to work in the morning?
Because you need a new set of golf clubs, or sneaks for the kids, or a leather
coat to go with that leather skirt, or to pay rent, and mortgages, etc. But,
we work so that we may consume, in some form. What are you doing when you
invest? In effect, you are "delaying" your consumption. Why would rational
human beings delay their consumption? The only reason to do this is because
the result of investing is a positive return on your money. Otherwise, if
the returns were not positive, people would not invest. Well, you may ask?
Why do people gamble? Are they irrational? To which I reply "As a people,
we do not gamble, but we do invest." There is also an entertainment "value"
associated with gambling that I haven't talked about.
CONCLUSION: For every dollar that you invest, you fully expect to get more
than that dollar back because 1) Historical performance dictates it, and
2) we as rational people would not invest with the magnitude that we do unless
a positive return was realized.
BOTTOM LINE? Your money and your hard work are too valuable to waste with
gambling and speculating. Invest your money in the stock market. This Fool
believes that with a little hard work, a little common sense, and a whole
lot of Foolishness, you can not only get more than that dollar, but you can
feel comfortable and confident about it at the same time!! Fool on !!!
By