A recent visit to a casino – strictly as an observer and not a participant – and seeing the business model brings out the stark difference between investing, speculation and gambling. Quite often we notice people confuse one for another and more importantly back it up with their hard earned money.
Speculation is the easier one of the lot. Assume 2 friends sit together for a game of cards. Both bet Rs 100 each. At the end of the game, assuming that one of them lost Rs 100, (since it is a friendly game) the other person would have made Rs 100. Mathematically, it is a zero sum game. The total gains will equal the total losses. Many ‘investment avenues’ that one sees around us are actually speculative in nature, i.e. not all participants can make money at the end of the day. One makes some money at the cost of someone else.
Gambling, on the other hand is a negative sum game. If 2 people walk into a casino, and assuming there were only 2 visitors in the casino that day, if one person loses Rs 100, the other person need not have made Rs 100. His gain will be much less than Rs 100, say close to Rs 70. The balance Rs 30 will go towards covering the costs of running the casino and taxes to the government. Lottery as a system is also similar. It is a negative sum game.
The first job of any investor is to completely shy away from all activities which resemble gambling. Chances are that you will lose money at the end of the day.
The idea of investing assumes it to be a positive sum game. If 2 people invest Rs 100 each, both can take home a sum great than Rs 200 on a combined basis. Many options to put money in play needs to be evaluated against this basic principle. For example, the currency market generally tends to be speculative in nature. Based on past evidence, equity market investing tends to be a positive sum game over time. If one adjusts for inflation, even investing in bonds in India today is probably a negative sum game after taking into account taxes.
One of the reasons why we are strong believers in equity markets is that the system is very conducive for investing over time. One buys into slices of companies which are growing, earning profits, which over time get paid out to shareholders. Buying into such companies will definitely yield gains over time. Companies which fail the test of their ability to make profits and pay them to shareholders are not investments. They are more speculative or gambling in nature.
The question then is why do people gamble at all, if the odds are stacked up so much against them? I suspect it is that dream of immediate quick and large gains and for some it is also the adrenaline rush of winning. We can also ask the same question about investment. Why is it that people don’t always choose good investment avenues? It is probably because this path requires lots of patience and faith.