Gambling Or Investing?

A couple of years ago I was teaching a course at a local college and a student, knowing that I was in the investment management profession, stated that she thought investing in stocks was akin to gambling.

According to my American Heritage Dictionary, gambling is “Betting on an uncertain outcome; Taking a risk in the hope of gaining an advantage; or Engaging in reckless or hazardous behavior.” Given the definitions, investing in stocks, bonds, or other securities could be considered gambling. After all, one never knows when they buy a bond if the company will be in business when it comes time to collect and pretty much everyone has figured out the stocks can go down as well as up.

Yet, I think that my student wasn’t thinking of the dictionary definition of gambling, but rather pussy888 kiosk download was comparing investing in stocks to be the same as pulling the lever of a slot machine, throwing the die in a game of craps, or playing black jack. Is investing the same as these activities? It doesn’t need to be.

Statistics show that Vegas-style gambling in the long run will lose you money. After all, that is how the casinos can afford to build pyramids, castles, and pirate ships. Investments, on the other hand, give you gains over the long run. Certainly all investments have some form of risk associated with them; risks that are accepted in the hope of gain. This is where we can take a lesson from Vegas.

What does Vegas have to teach us? You can put a quarter in a slot machine and win $100, $10,000, or even $1 million. How can the casino survive giving away money like that? You know the answer: because most of the time you put your quarter in and walk away with nothing. Sure, now and then someone walks away a winner (and tells all their friends back home) but most people most of the time lose money. The casino can survive because they are prepared for the occasional winner and can be quite patient while all the rest of us hand over our money. They don’t close down the first time someone wins, distraught over their bad luck. They keep at it knowing that they’ll get that money back and then some.

To understand investment risk, investors must accept certain fundamental truths. First, there is no such thing as a risk-free investment. Second, investors seeking greater investment rewards must be willing to accept greater risk. Conversely, if an investor is unwilling to accept a given level of risk, then they need to lower their expectations. Third, the risks an investor faces can vary depending on how long an investor has to achieve her or his investment goals. Finally, while risk cannot be eliminated, it can be managed through careful planning and following a disciplined investment process.

One form of risk that everyone understands is “principal risk.” That’s the risk that you buy an investment (a stock, bond or parcel of real estate) that suffers a permanent decline in value. The Exxon bankruptcy is a perfect example, its bondholders may only receive pennies on the dollar for their interest-bearing bonds and stockholders have seen their investment go to zero.

This risk is easily removed by investing in a diversified manner. Don’t buy just one stock or bond; buy dozens from different companies in different industries. Too hard? Then use a mutual fund to do the diversifying for you.

Another risk investors face is volatility. That’s the chance that on any given day, the financial markets might value your investment at a price greater or smaller than it did yesterday. Almost all investments are subject to the risk of volatility. Even rock-solid U.S. government bonds fluctuate in value when interest rates move.

With volatility, owning a bunch of stocks, bonds, or a mutual fund won’t get you out of that risk. Instead it takes time–time for the downs in the market to be overcome by the ups. Each type of investment has its own characteristics. Some require only a few months for the ups and downs to cancel out, some take decades. You will need to match your investments with the time you have for them to grow. The more time you have the better growth you can shoot for.

But the risk that most investors ignore is inflation. This is the risk (pretty much a sure thing) that the purchasing power of a dollar goes down. For example, over 25 years (the length of retirement for many people) an inflation rate of 3% will rob over half of the purchasing power of every dollar you have. Trying to avoid principle risk and volatility risk by sticking with CDs or other guaranteed income accounts makes it hard, if not impossible, for your investments to grow faster than inflation.

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