There are key differences between investing and gambling, but after the great recession of the late 2000s many believe that they might as well be the same.
The reality is that it’s your approach to investing that determines how many parallels can be drawn between the two.
Investing or speculating
Most people realize there is a difference between an investor and a speculator, but often don’t know what that difference is.
Imagine that you’re at a casino. The speculators are the gamblers looking to make a quick buck on a night out. The investors are the casino owners who know the odds are in their favour over the long run and who keep their doors open even if they lose to the gamblers on a given day. Although a handful of gamblers will occasionally get lucky, all the casino owners will eventually become wealthy.
Are you an owner or a gambler?
When it comes to financial instruments, an investor looks to create wealth through long-term ownership of the instrument’s underlying assets. In regards to stocks, the asset would be the company and that company’s future cash flows. Before purchasing an investment, an investor will be concerned with the true value of the underlying asset (or company) relative to the price you have to pay to own it.
If the price is lower than perceived true value and the investor believes the long-term return should more than compensate for any risk, the investor will buy the investment and hold on to it until it is overpriced relative to its value.
Price or value
Speculators are interested in only one thing—price. The value of the underlying asset does not concern them. They want to pay a price for something today and sell it at a higher price in the future. Speculators chase trends or hot investments hoping to get out before the trend ends or the investment goes cold. They are often the ones investing in bubbles, assuming they will get out before it pops, and they will often use leverage, amplifying any gains or losses.
Don’t be the fool
Speculators follow the greater fool theory. They assume they will be able to sell an asset at a higher price in the future to a greater fool than themselves. The problem with this is that, eventually, someone is the greatest fool and buys just before the bubble bursts. You don’t want to be that person.
Speculators may get lucky once or twice, but playing the game this way puts them at risk of losing their wealth. So don’t treat your investment funds the same way you’d treat your spending money in Las Vegas, there is a smarter way to make money.