In this two part mini-series I have been addressing the differences between investing and gambling. In part one we looked at the idea that the difference between the two is a spectrum, with investing with perfect data on one end, and gambling with no information on the other.
Let’s revise what we covered in part one and look at what how we are differentiating between investing and gambling. On one side we have investing having already obtained a wealth of knowledge about the underlying economic health of the thing we are investing in. This data represents information on the likelihood of a return on our investment. On the opposite end of the spectrum we have gambling where we are throwing our money at something with very little data available on its future prospects.
So now we have the spectrum laid out, lets work through some examples to illustrate these different ends of the spectrum
Real estate = Investing
When done properly, investing in real estate is towards the investing side of the spectrum. You can look at the mortgage details, rent, expenditures, maintenance costs etc. You might even send over an inspector to check the building over before you close. You can crunch the numbers and have a pretty decent idea of potential outcomes. You could even calculate a long-term plan how much you want to earn and by what date. You might not be able to tell how much a market can go up or down, but you can look at historical trends to gain an idea. Furthermore, the macroeconomics of a specific housing market are not going to change rapidly overnight. You will have time and data available to readjust your position or change your exposure to the market. Even considering events that might change a market overnight, such as an earthquake, if you have earthquake insurance for then you have more data on potential outcomes because your loss is covered.
Cryptocurrency = Gambling
Turning to the other end of the spectrum, investing in cryptocurrency can be considered a gamble for a number of reasons. Primarily, there are currently no widespread use cases for cryptocurrency. There is no inherent value attached to cryptocurrency. This means there is almost zero data available on things such as profitability, growth potential, assets, risks or any of the usual microeconomic factors that you would normally explore before investing money. Furthermore, you have no idea how markets or governments are going to react to this space in the future. All the money currently going into the cryptocurrency space is based on pure speculation. Therefore this is gambling.
Stocks = Somewhere in the middle
Some people consider investing in stocks to be gambling because you don’t really know the outcome. You don’t have a lot of data on what the outcome is going to be like. This is debatable as you can conduct fundamental analysis on a company and ascertain at least some information. You can also survey the macro and micro economic landscape to obtain further information on the health of your investment. I would argue that people who think investing is gambling are probably not doing enough due diligence. Therefore, buying stocks may lie somewhere in the middle of the spectrum.
However, please remember that this is a spectrum and it is important that you are aware of the differences between investing and gambling in order to allocate your assets properly. I certainly don’t want to discredit gambling too much. Gambling can be fun and sometimes the payoff is huge. But gambling can also be dangerous because it is a lot more exciting and a lot more addictive. The important thing is to be aware when you are gambling and only allocate a very limited set of money to gamble with. So don’t overexpose yourself to an unnecessary amount of risk. Understand exactly where on the spectrum your opportunity lies and allocate your money accordingly. Don’t get caught gambling when you thought you were investing.