Investing or Gambling?

.........or: "Is investing a gamble?"

Do you like to gamble?

Some of you do, some of you don't.

Do you like to gamble with your life?

A very few of you do, most of you don't.

To those of you that don't: How do you decide whether to make a journey by car or by train? Does the fact that the train is much safer than the car influence you? When you choose the car because it is more convenient have you 'gambled with your life'?

Well you have, actually. What you have done is ignored the extra risk of death and injury because of the increased convenience. But it doesn't feel like that does it? It just feels like a reasonable way of carrying on.

The fact is, all of life is a gamble. We make choices all the time that increase the chances of some things and decrease the chances of others. We just don't think of it that way. Rightly.

You can see where this is going. Investment is a part of life and....

All investment is a gamble

It's important you get used to this idea. There is no 'safe' way of investing.

Do you think putting cash under the mattress is safe?

It is true is that the outcome is certain: you will have exactly the same amount of money at the end as at the beginning. The trouble is that you don't actually want money: you want the things that money can buy. And inflation will ensure that you will be able to buy less at the end than you could have done at the beginning. You have gambled with inflation. Investing in almost anything else would give you better protection against inflation ...... in exchange for taking other risks.

Do you think shares are risky?

Suppose we said that we can offer you two different investments, A and B, which have been around for a hundred years. And on the basis of that 100 year history B has outperformed A over any ten-year period 97% of the time. Which one would you chose? You'd choose B, of course. And you will have guessed that B is shares and A is cash (with interest).

So it's not so straightforward is it?

My mother taught me that gambling is bad

....and your mother was right, for her version of gambling.

Take roulette as an example. There are two things about roulette (and all forms of gaming) that make it stupid, financially. First, you swap certainty for uncertainty. (If you bet £1 on red you are about equally likely to get nothing or £2). Second, the zero on the wheel always goes to the bank. So, with 36 other numbers on the wheel you will on average lose 1/37 of your money - just under 3%.

So roulette is a bad bet. In the financial jargon it is high risk and low return.

Investment is a different game of roulette

.........and the big difference is this. Zero pays out to the player, not the bank.

Suddenly we have a completely different kettle of fish. Now, on average, the player is going to make money. But he has uncertainty. Is the one worth the other?

On a different table there is another roulette wheel. It's got two zeros! Wonderful! Double the payout! But there's a catch: he can only bet on single numbers - he can't bet on the colours or the number groups. So he wins much less often but he wins much more when he does - on average twice as much as on the normal wheel.

Which wheel would you want to play?

That's the investment conundrum in a nutshell. How much compensation do you want to take how much risk?

But it's still a betting game. And, like all betting, it's governed by the iron laws of probability. If you thought it was something to do with hot share tips from you friend at the golf club, think again.