It is a good financial practice to measure one’s risk tolerance and then invest based on the results. On the other hand, I’ve received some complaints about this strategy. Reading up on all sides of an argument can help you learn a lot about a topic. There are frequently truthful nuggets peppered throughout. In the following two sections, I’ll look at one of those reasons that people use to end a conversation before it even begins…
Why expose yourself to the risk of investing?
I’ll now restate two of the reasons that have been offered in favor of this point:
- Investing is nothing more than a series of different types of gambling and Ponzi schemes.
- Investing does not require you to jeopardize your financial resources in any way. Simply reduce your expenditure to save more money over time. You can insure it by first depositing it in a bank.
Have you ever invested or gambled?
At its essence, investing includes taking a risk with the true intention of being compensated for that risk. Simply putting food on the table necessitates regular risk-taking and investment.
I just spent some energy and effort retrieving a slice of cheese from the refrigerator. I was worried about tripping over the hyperactive puppy that was bouncing up and down between my legs as I walked back to my workstation. That may have ended in me getting wounded or wasting all of my cheese. I’m going to assume she meant to leave out the cheese.
We are willing to risk not only our money but also our time and effort, sometimes known as our human capital, in search of a fulfilling line of work. People who wish to get into medical school take a considerable risk because the chances are stacked against them because of the competition. We placed a large amount of our financial wealth at risk once we were already in medical school. We foresee a raise in our salary in the future, which will allow us not only to repay the debt but also to reap the benefits of that greater income for the remainder of our working life. Those who have school loans may view this as a type of leveraged investing.
What distinguishes investing from gambling in terms of one’s financial future?
The line that separates investment from gambling can be difficult to discern at times, which is one of the reasons why people dispute it so frequently. Some qualities that can help us distinguish between gambling and investing are as follows:
A chance game versus something with intrinsic value
The term “short-term” refers to the average length of a gaming session. It could be seconds for a slot machine, hours for day trading, weeks or months for a speculative stock trade, or years for a speculative real estate acquisition.
The typical investment time horizon ranges from several years to several decades. Investing, of course, cannot be restricted to a set time frame. There are some amazing prospects available for short-term investing. As in my experience with the cheese.
“Chance” and “The Odds,” to name a few
Typically, gambling is a game of chance rather than skill. It is impossible to protect oneself from the random likelihood of anything bad happening. Casino gambling is subject to several rules and regulations. Statistics are employed to calculate the likelihood of winning and the amount of the payment. In the background, they are conspiring against you. Even if you make every effort to play correctly, the house has a 0.5 to 25% advantage in popular casino games. This is true even if you do everything possible to win. Although the outcome of each round cannot be anticipated with full confidence, a loss is certain if the game is played through a sufficient number of iterations. According to the mathematics instructor I had in high school, gambling is a form of an implicit levy on mathematically illiterate individuals.
Putting one’s money on the line
When you buy stocks and bonds, you are effectively betting that the economy and humanity will improve over time.
Although there is no certainty, the chances are stacked in your favor. Unlike a casino, the likelihood of a successful outcome in the financial markets increases with the amount of constant time and effort put into them.
The ability to manipulate the market exists. However, manipulating financial markets on a large scale in a world that is multifaceted, interconnected, and has a free flow of information is far more difficult than playing a game of chance in a casino. Those wearing tin foil hats may have a different opinion. On the other hand, we have evidence spanning several years that shows it has been a success up to this time.
Lightning could strike at any time and cause irreversible damage to the world economy. Having said that, I’m not sure I’d want to be wearing a metal helmet in those situations. Why do people continue to bet if they are guaranteed to lose? The answer is found in the potential return on investment. Gambling bets often have an “all or nothing” outcome. You either lose the money you wager or make a significant profit. Remember from Psychology 101 that random intermittent reinforcement can significantly increase a behavior. Even more so if there is a substantial prize at stake.
To be successful, you do not have to bet everything on a single investment. The value of your investments will rise and fall. On the other side, they should be extremely unlikely to reach zero or the moon. When the likelihood of an event increases, an “investment” is regarded as more speculative. Even the most conservative investments involve some level of guesswork.
The act of speculating on investments
Less speculative investments tend to vary at less dramatic levels because they are related to assets and productivity. A business that sells a product or offers a service, such as a manufacturing or retail establishment, is an example of this. Another example would be a rental property in a safe neighborhood that was purchased at the right price and has a continuous flow of revenue. Similarly, the government’s assets and taxing authorities are utilized to support bonds issued by the government.
A company that possesses a concept, no matter how creative, but has made no obvious progress in generating a product or service is far more speculative than other enterprises.
We raise a glass to you, dot-com bubble. The internet’s potential was the motivating force behind it. Amazon and Google are only two instances of corporations that reached maturity and were able to make large payments. The figure fell from hundreds to zero. Extremely rare, yet with massive payoffs. There is a good chance that you will lose everything. Gambling.
An investment’s designation as either extremely speculative or safe may change over time. Over time, an investment’s status as either extremely speculative or safe may change.
During the dot-com boom, there was a lot of speculation about a lot of companies that had “potential” but didn’t create or provide any product or service. It is now time to invest after the survivors have been chosen and the appropriate services have been given. There is a continuous shift across the spectrum that may be linked to a company’s potential for expansion (which is more speculative) and the value that the company now delivers (less speculative).
“Investment” in anything very speculative exposes one to a significant risk of huge profits or losses. It is the zone where successful gambling and investing may collide. Don’t make your investments a gamble by taking unneeded risks.
How can we tell if an “investment” is truly just a gamble for us?
When you make a risky investment, you are betting on the likelihood that something or someone will want it in the future. Furthermore, they are in such desperate need of it that they are willing to pay a higher price for it than you did. That is dependent on the emotions it evokes in others (mainly “fear of missing out” or greed).
Significant price changes (volatility) connected with a speculative investing play on investors’ emotions. If the judgments you make about your assets cause you emotional distress, you have exceeded your risk tolerance. It is also possible that you are gambling. Gambling can be thrilling, but it can also be frustrating since it tests your emotional investor beast. If you allow Investor Hulk to rule your behavior, you will end up making costly mistakes.
Stock market gambling for the sake of amusement
Investing in the stock market, in my opinion, should not be considered “fun” (except for the reading of the Loonie Doctor blog part). Some people keep a modest amount of their “play money” separate from the rest of their portfolio. They don’t mind losing everything, and the only reason they buy things is to have fun with them. The adrenaline rush of going hunting. It’s like going to a casino just to enjoy the ambiance and activities without considering whether or not you’ll walk away with any money.
It’s entirely appropriate to look at it in that light. Check to see if you’re getting a good return on your investment in terms of “pleasure units” for the money you’re spending. When you consider the amount of time and money necessary, it may be a costly way to play. It’s more important to me to spend my “play money” in ways that will give me the most pleasure and have the most influence.
If there are any warning indications, you should think about them for a time
If you make an investment that promises large short-term returns, excites you, or worries you, this is a red flag that you are gambling. The thrill and worry that accompany making one’s first investment may be an exception; yet, this is quite typical. When there are no actual assets, products, or services associated with an investment, a red flag is raised. You could be involved in gambling or speculation. If someone offers you an investment with a higher advertised pay-out than where it stands on the speculation spectrum, you should be suspicious. This should serve as a red flag that they are either intentionally or unintentionally attempting to deceive you in some way.
Do not consider your investment to be a type of gambling
There are several different ways to turn what should be beneficial investments into risky ones:
- Insufficient time frame
- Poor behavior is a direct result of exceeding our acceptable degree of danger
- Our ability to endure risk is hampered by bad behaviors
Let’s investigate how anything like this could happen:
- Having a “time horizon for investments” that is less than what is appropriate for the investment at hand
- Having a stock portfolio is a bet on the idea that the economy will grow, which has traditionally been a relatively safe bet.
- Having stated that, this will require a significant time investment. Every day, the stock markets see a wide range of price changes.
Trading is the act of purchasing and selling shares of a company’s stock to benefit in the short term
When you trade, you’re effectively betting that you know which way the market will move in the short term and trying to “time the market” to buy low and sell high. In other words, you are making predictions. To be successful, you must be able to see into the future. Not just once, but twice overall. The first is when you purchase, and the second is when you sell.
Buy low and sell high returns
Historically, the “buy and hold” strategy has been beneficial over longer time horizons. I am not aware of a single trading approach that is profitable in the long run. Trading is a tactic that some people use to outperform the market. There’s a good possibility that you and I aren’t among them. A short amount of time may convert what might have been a safe long-term investment into a dangerous one.
If you continue to buy stocks while you have outstanding student loans, you are engaging in leveraged investing because you are not paying off your loans as you would otherwise. Investing on margin entails borrowing money from your brokerage business to purchase additional securities. Some investors even use their existing lines of credit to supplement their portfolios. Leverage, leverage, leverage!!!
There is a chance that the lender will demand loan repayment when using a line of credit or a margin account. This is usually done because they are concerned that you may be unable to repay the debt. That phase usually corresponds to a market downturn. The absolute worst time to sell your house.
When there is a chance that you may be unable to make timely payment or that the loan will be called, the risk level connected with leverage rises. If your cash flow is restricted and your immediate earning potential is limited, you are at a higher risk. I’m specifically thinking of medical school and residency. They will improve once you finish what you’re doing and have that bigshot looking after the big. On the other hand, you have no idea what will happen in the time between now and then. The risk may be greater than you believe.
Leverage, even when used responsibly, has the effect of magnifying both gains and losses. Do you recognize the concept of using leverage to obtain huge rewards despite the danger of suffering large losses?
When you use too much leverage, you risk having a short investment timeframe that is out of your control. That would have been a sound long-term investment, but it’s now a risk. Furthermore, leverage magnifies sensations and emotions. By engaging in questionable behaviors, you might increase the emotional intensity of your investments.
As previously stated, stimulating one’s emotions can be an indication that one is taking too many risks or even gambling. Furthermore, emotions can cause you to turn a successful investment into a risky gambling enterprise.
If you play on your emotions, the near future will take precedence over the far future, causing you to lose sight of the big picture. Your more primitive brain craves more of the pleasurable feelings produced when the value of something grows. It wishes to reduce your distress whenever you see that the size of your funds has shrunk even further than before.
You may decide to diverge from the plan due to the emotional pressure you are experiencing. It encourages you to engage in risky trading with a too-short time horizon rather than making investments over a longer period. You should not underestimate your primitive brain’s capacity because it has contributed to the human race’s survival for millions of years.
Speculating on the stock market
You can limit the degree of emotional thrill you feel by not checking the value of your longer-term investments on a regular yet sporadic basis. This is a significant psychological advantage for the real estate industry. The value of your home is not advertised on your front lawn in an up-to-date manner. It’s also not possible to buy or sell it for less than 10 bucks by merely touching a smartphone button.
That is something that, for better or worse, can be accomplished with both stocks and bonds. It is beneficial to avoid monitoring your investment portfolio too regularly and to avoid daily financial news sources.
It’s easy to get away with mocking your Bruce Banner Investor a few times a year, but it’s not a good idea to do so with daily volatility. Using leverage in conjunction with this is akin to presenting him with a nugget. He’s not someone you’d want to be around while he’s enraged.
If you anger the beast, a long-term investment may be reduced to a much shorter time frame. When looking at the short term, investing transforms into trading. Gambling.
Do you intend to gamble or invest your money?
Gambling and investing are two behaviors that can result in both losses and gains. A savvy investor can increase their odds and have less dramatic wins and losses. Rather than relying only on chance, investments are intended to represent some underlying value. Investing is often done over a longer period. Gambling, in contrast to investment, tends to elicit strong emotions in people.
You can’t build a meaningful career without taking some risks, and you can’t enjoy rewards without taking some risks. Even the most conservative investments involve some level of guesswork. Make every attempt to invest instead than risk. Be extremely cautious not to let your investments veer toward the gambling end of the spectrum by doing things like selecting an inappropriate investment horizon, overleveraging, or participating in poor investor behavior. Rather than trading for the short term, invest for the long term.