Don’t gamble with your investment money
Gambling has become all the rage again, particularly online gambling. I’ll leave the discussion as to whether or not that’s a good thing to another post.
But there’s another kind of gambling that’s also taken off, and it has me a lot more concerned; it’s basically gambling in the guise of investing. I’m specifically referring to three things, all of which have been in the news (or have been THE news) since 2021 began: cryptocurrency, the “wallstreetbets” mania of January and related tactics, and options.
I promised a few weeks ago to write a post discussing the difference between investing and gambling, and I wanted to do it sooner, but before I discuss the three items in the previous paragraph, I’ll give you my take on what separates an investment from a gamble.
Most finance books and finance articles define a gamble solely on the amount of risk involved. Something with a high level of risk is usually called a gamble, while relatively low risk activities can be called investments. I disagree that this is the only dimension when it comes to separating investments from speculations (gambles). I believe there are four factors, four criteria that have to be met for something to properly be called an investment.
Criteria #1: Level of Risk
The first criteria I’ve already mentioned: level of risk. This is a rather subjective criteria; exactly how much risk is too much? I don’t think anyone can adequately quantify it, so we’ll leave this as a subjective measure (they’re all subjective to one degree or another, but so are most things in Finance!). When it comes to Criteria #1, an oversized level of risk equals a speculation; a reasonable amount of risk can lead to something being called an investment.
Criteria #2: Meaningful Data to Analyze
Next, there needs to be objective, meaningful data to analyze about something for it to be called an investment. There has to be an adequate level of data that can help you determine the intrinsic, or real value of something before you spend money on it. There is no way to determine what the intrinsic value of Bitcoin (for example) is. The only data to be observed are the number of Bitcoins in existance, but that tells you nothing about what one Bitcoin is worth. Gold is the same; it has few industrial uses, and the total supply is always changing. What is the intrinsic value of Gold? Your guess is as good as mine, but if you have to guess, that’s not good enough.
I say “meaningful” data needs to be present because, to take another example, Roulette does provide the player with current data to look at. Almost every Roulette wheel in a casino (even online casinos) has an electronic board that gives you the last 20 numbers that have come up. However, since every spin is a unique event, what number came up last means nothing toward the probability of which number will come up next. If 2 hasn’t come up since last August, and 5 has come up the past three spins in a row, 2 is no more or less likely to come up on the next spin than 5 is. The board and its “data” are totally meaningless.
Last semester, when talking about investments vs. gambling, I only had time in one of my lectures to discuss this particular dimension. One of my students very astutely pointed out that, on this basis, sports betting could be considered an investment, since there is a great deal of objective, meaningful data to analyze. Based on what I said in the lecture, this student was quite correct. But as we add the final two criteria to the mix, you’ll see that sports betting is in fact a gamble.
In Part 2 of this post (which I’ll post tomorrow) I’ll discuss Criteria 3 and 4 of what separates an investment from a gamble, and in Part 3 I’ll analyze a number of different things (including Bitcoin and options) to see how well they meet the criteria.
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