The best way to grow your wealth is to invest in the stock market.
If you don’t believe me, listen to Warren Buffett; he advocates that retail investors put 90% of their money in a fund tracking the S&P 500 American stock index. He himself got rich, not by buying the index but by picking shares in successful companies. And yet, you often hear the comments that investing in the stock market is like playing the roulette wheel in a casino. Is that so? And if not, what is the difference?
The short answer is “no”, investing in shares is not the same as gambling. Over time, stock markets in the US, Singapore and virtually any other country or jurisdiction you can mention have been going up; this rising tide has been lifting all boats and made investing in the broader stock market over the longer term a fairly safe bet.
Yes, there is a risk involved. But this risk can be mitigated. Systematic risk (or market risk) means that recessions and deflationary periods in the economy can cause the value of your portfolio to fall temporarily. However, markets have historically always recovered and provided a positive return, so by holding your quality shares for the long term, you can still do well.
Unsystematic risk relates to the risk of individual companies and sectors within the economy doing poorly; that risk can be reduced by analysing each company you buy into carefully, as well as by constructing a portfolio diversified over several different companies and preferably across uncorrelated sectors.
Just don’t confuse taking on a calculated risk with gambling. A calculated risk is starting a new business you think will work – or investing in one; we can all be winners in such an endeavour.
Managing risk vs gambling
Gambling, however, is flipping a coin and hoping that either heads or tail will come up; there is no data to analyse and you have no control over the outcome. Gambling is zero-sum: if you win, someone else will lose. In the same way, buying binary options and trading in futures and other financial derivatives is a zero-sum game, in other words, gambling.
And here’s the catch. Let’s say that you have some dollars. You play a 50-50 game with an opponent who has an unlimited number of dollars. Did you know that if you keep on playing, you will always lose all your dollars? If you didn’t know that, maybe you shouldn’t trade binary options and other derivatives.
Math of gambling: The house always wins
The theorem is called “gambler’s ruin” and it is not really that hard to understand. If you flip a coin, the chance of head or tail is 50-50 or 50% for each toss. So let’s say you only have one dollar coin, your opponent has a lot. You might be lucky and win, then you have two after the first toss, but you have already used 0.5 or 50% of your luck after the first toss.
If luck goes against you twice in a row after that, the probability of that is 0.5 (you lose one dollar) X 0.5 (you lose the other one) = 0.25. But this has to be added to the 0.5 chance you already used, and you cannot play anymore. Your chance of going broke will always be more than 0.5 or 50%.
In more general terms, if you have more than one dollar, say N(1) and your opponent has N(2) dollars where N(2)>N(1), the probability (P) of you going broke is P = N(2)/N(1) + N(2). Since P will always be more than 0.5 or 50%, you can play all night till the cows come home, you will always lose all your money in the end.
In my book, 'Be Financially Free' (Marshall Cavendish, 2016), I elaborate some more on the implications of this, but this is really all you need to know as an investor. Financial derivatives, lucky draws, 4D lottery, online football games… all this stuff is gambling. The odds are stacked against you, the house always wins. Don’t think your lucky tie will help you, or that betting on your girlfriend’s birthday numbers will bring you luck. Numbers don’t work that way, and you have to understand and respect the math.
I made the decision when I was a kid never to gamble. I have been to a few casinos with friends and enjoyed a free drink; but I never sat at the roulette wheel. I never bought a lottery ticket; I don’t even fill out “free” lucky draw coupons. I advise everyone to do the same, it is a load off your shoulders once you realise that gambling is not the kind of thrill you need. To progress, do take on some calculated risk, but never gamble with your (financial) life.
If you ever need a personal loan, always remember to compare interest rates being offered by the banks, as well as the various terms and conditions. Check our summary of the Best Personal Loans in Singapore 2019 for our recommendations of the best loans based on different needs.
Read these next:
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By Morten Strange
Morten Strange is a Singapore-based financial analyst and author of The Ethical Investor’s Handbook (Marshall Cavendish, 2018). He retired at the age of 33 and has spent the last 30 years living on passive income from his various investments. This is his story.
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