We’ve often heard investors speak about a hot new “investment” they’ve made. Take the most recent trend of investing in cryptocurrencies. For a lot of people this is not an investment, but rather a gamble. No research was conducted, the investor may be acting on a tip from a friend or relative and hoping for a quick (very profitable) return. Or maybe your friend has decided to put some money in a penny stock, hoping for a quick return. Such examples are numerous in investing. Investors make high-risk bets, acting on very little information, hoping there’s a high payoff in a very short time period. In these cases, just because you didn’t walk into a casino doesn’t mean you’re not also gambling; in this case, with your financial future. Investing on the other hand is rooted in research, risk management, and usually has a long-term horizon. While gambling and investing both involve risk of capital and offer a potential future return, understanding the differences between these two activities is key to long-term financial success.
In this article we’ll discuss the difference between saving, investing and gambling. Three activities which are often confused for one another.
Saving is simple. The primary role of saving is building a surplus of wealth. Putting away a percentage of your income each month is saving. Your savings may be designated for something in particular: a down payment on a new house, a car, emergency fund, vacation etc. If this is the case, and you expect you’ll use the saved money relatively soon (within 3 years), it’s best left in cash or cash-equivalents with no risk to the capital.
Examples of saving might be:
- Putting money into a savings account at the bank
- Buying short-term Government of Canada Bonds
- Purchasing short-term Guaranteed Investment Certificates (GICs)
While putting your savings into a bank account, short term bond or GIC will not offer a financial return (you may receive negligible interest) it ensures your funds will be available when needed. This is a no risk, no return strategy.
Investing involves preserving and growing capital over the long-term – it is key to building wealth. Any savings not intended for use in the short-term should be put to work and invested. Investing is higher on the risk spectrum than saving, however, when decisions are informed, based on knowledge and research, and handled by an experienced professional, the risk can be minimized for maximum return. Furthermore, it’s worth noting that investing is a long-term game. So, if your investment horizon is 5+ years, investing is the best option to grow your wealth.
Examples of investments might include:
- Owning stocks or bonds of publicly-listed corporations (ex. Amazon, GM)
- Owning income producing real estate (ex. rental properties)
- Owning a business, or a portion of a business
Investing in a strategy that aligns with your risk tolerance and financial goals is the best way to preserve and grow your wealth over time.
Gambling is a risk-taking activity that’s undertaken on a chance (often a slim one!) that a large reward could be earned. The difference between investing and gambling is one of expectation versus hope. When we talk about investing, there is every expectation that your savings are being invested to deliver (though never with 100% certainty) comparable yield a risk-adjusted return.
Gambling, however, does not come with any set expectations, but with a hope that the gambled savings will produce a return. Gambling often has binary outcomes: You win it all, or you lose it all. Investing usually comes with rewards comparable to the risk of the investment.
Riskier investments can deliver higher returns (although this is never guaranteed!). Less risky investments are likely (though, once again – never certain) to deliver less losses than riskier ones. When you gamble with your savings though, you risk the chance of losing it all (or a significant part of it!).
Gambling could comprise of decisions such as:
- Using $10,000 to buy dozens of Loto-649 tickets because the stake is $75 million!
- Lending money to a friend of a friend’s distant relative, in the hope that his African tin mine investment will start delivering you $1,000 monthly profit checks next year
- Buying thousands of US dollars today, believing that your investment will double in a week’s time due to exchange rate differences
Unlike most investment decisions, which look to preserve and grow capital, gambling decisions usually don’t expect to preserve capital; and they just hope to grow it.
Investing Vs. Gambling – Knowing the Difference
Both investing and gambling can offer profit. Both expose you to losses. And both carry elements of risks. Due to these high-level similarities investing and gambling activities can be confused. For example, conscientious savers, who have built a sizable nest egg through hard work and prudence, will hear about an “opportunity” with great potential, and will rush to invest in it without understanding the risks. That’s NOT investing – it’s gambling. Hoping to reap the rewards from a financial decision, without understanding the risks that such decisions entail, is gambling.
That same opportunity could be a good investment. If you’re well informed, the opportunity has been researched, analyzed, and shows good reward potential for the risk you’ll take it is a sound investment decision.
Another difference between what constitutes gambling and what governs investing is diversification. Good investments (like a balanced portfolio of stocks and bonds) have built-in diversification as part of their risk-mitigation strategy. With gambling, the risks and rewards are usually concentrated into a single “opportunity”, with no safety net in case something goes wrong.
More significantly though, when you invest – whether it’s in stocks, mutual funds or property, you actually “own” a piece of that entity. For instance, investing in 100 shares of Apple Inc., makes you a part owner (to the extent of the value of your investment) in Apple. There’s no such ownership when you gamble – it all belongs to the “House”!
Investing is about long-term benefits, while also managing risks in between. So, if you are faced with an “investment opportunity” that doesn’t offer any risk-management, that “opportunity” is like to be a gamble. Stay clear of it!