It’s human nature to have a fear of the unknown. And when it comes to money things are no different. One of the main things I see that really holds people back from investing or even opening a retirement account is the fact they really struggle with understanding how the market works. They can’t help shake the feeling that they are “gambling” with their money and livelihood.
The following post is a contribution from The Money Template, a personal finance blog trying to tackle everything about money and how we can save more of it.
As someone who has lost money with their investments, I can completely identify with that fear. I’ve watched my 401k balance get cut in half during the dark days of the Great Recession. I’ve had stocks I own go all the way down to having no value at all. But one thing I can tell you is that it doesn’t always have to be that way. In fact there are quite a few basics that you should get to know that will help you understand that investing is not gambling and to keep your financial faith.
Companies are Businesses, Not Chance:
The first thing you need to understand about stocks and mutual funds is that you’re not putting your money on red or black at the casino. Casino games and most gambling in general is designed to do one thing and one thing only – make the owner rich. There is no skill or craft involved. The wheel spins and dice roll. It’s a game of odds designed to make the patrons think they have a chance when really the house will ultimately win every time. As the old saying goes “a fool and his money are soon parted”. Now compare that scenario to the way the economy works. When it comes to big, legitimate businesses, they don’t merely rely on “luck”. There are business plans, product development, strategic planning sessions, and lots of other things that go into driving a company towards profitability. People go to work every day trying to make that business grow and move forward. Any reputable company wants to survive and they reward their shareholders with growth and earnings.
But Isn’t Investing in Companies Still Risky?
You are always correct to assume that when it comes to investing there is always a risk. It doesn’t matter what you do with your money. There is always a chance that you could lose it. When you invest in stocks, it could go up or it could go down. It just depends on what happens that day. However every day people invest in the market for the chance that their stocks will go up in value. Possibly even double! Take any year between 1970 and 2013. If you had invested in the S&P 500 stock index, you could have lost as much as -37.0% or gained as much as 37.58% for any given single year. That’s a pretty huge spread of possible outcomes. Now consider a relatively safe investment like a bank account. Even things there are not always as safe as they seem. For example if you had a million dollars in the bank and there was suddenly a run on banks (think like the movie It’s a Wonderful Life), then you could potentially lose $750,000 since your account is only FDIC insured for up to $250,000. Now obviously those two examples have vastly different levels of risk. One is far more plausible than the other to happen. So if you accept that all investments carry some level of risk, the only thing you have to do then is ask yourself how much risk are you willing to tolerate for a decent return on your money? Surprisingly the two are not always as linear as you might believe. Especially when you add in one very important ingredient …
Time is a Great Equalizer:
Even though stocks by themselves are relatively risky, there is one very slick way to mitigate how much you’re willing to gamble: By giving it more “time”. Suppose instead of investing in stocks for a single year, you instead give it a little time to mature. Take any five-year period between 1970 and 2013 for the S&P 500 stock market index and the average return will be anywhere between -2.35% and 28.56%. Compare that -2.35% to the -37.0% you were faced with earlier and that’s a WAY less risky strategy to use. Now look at what happens when you keep stretching out the time period longer and longer:
- 15 year period average: 4.47% to 18.93%
- 25 year period average: 9.28%to 17.25%.
As you can see the longer of a period you give yourself to invest, the more it averages itself out. AND more importantly that average gravitates towards a stronger and stronger positive return. What this means is that for people who want to invest intelligently is that as long as they invest in large strong companies over the long haul they should expect all those yearly fluctuations begin to level out and deliver long-term positive results.
Investing is Not Gambling:
Even Warren Buffett himself has said that no one really knows what the market will do tomorrow. It might go up and it might go down. While that is absolutely true, it doesn’t mean that we still can’t become financially independent for the rest of our lives. As investors one of the best things we can do for ourselves is to put our money in market averages or solid, legitimate companies that will help produce well-deserved long-term results. If history is any indicator, you’ll find that out of all the strategies out there this one is simply a great way to minimize your risks and maximize your returns.
Soti Coker says
So true. Investing is not gambling if you pick good companies and invest for the long term. Picking the right companies is paramount though.!
That’s absolutely true about picking the right companies. Stick with the stocks from tried and true big blue businesses and your money is about as secure as if you had invested in bonds.
Jayson @ Monster Piggy Bank says
Investing is really risky if you don’t know what you are getting into. The moment when investing is not a form of gambling is when you know the world of investment itself.
Knowing what you’re doing is a 100% critical element to this whole thing. I never recommend people invest in anything other than what they know about and feel comfortable with.
There was one time I was one time I was reading about an investment strategy involving options and was considering giving it a shot. But then I realized I had no idea what I was getting myself into, and so I never carried through. Like many things there are fundamentals to investing that one must understand first before he fronts his money.
How To Save Money says
Agree! It’s about knowing the risks and knowing how to manage them!
Stefanie @ The Broke and Beautiful Life says
37% is a HUGE spread!
That’s exactly why investing for the short term is so risky. Could you imagine if you put the money you had earmarked for a house or new car into the stock market and it went down by 37%? Once you get up into the 10 or 20 year investment time horizon you can see that your return potential starts to really even out.
The Starving Artist Canada (@blerghhh) says
If you’re throwing money on “hot tips” from friends, it is gambling. Chances are that “hot tip” info is several years old.
As for Mutual funds… they ARE just like the casino: the HOUSE always wins. They are products that ALL lag the indexes and have HUGE fees designed to pay the HOUSE and it’s shareholders.
I will begrudgingly approve of low-cost ETFs for small accounts. But the real money comes from good companies, and option strategies on those good companies.
There really is no appeal to most mutual funds. If you just stick to the ultra-low cost ones from Vanguard that follow the indexes and offer you diversification, that’s really all you need to capture the market returns like those presented above.
The Starving Artist Canada (@blerghhh) says
I can’t afford to buy and hold low cost ETFs. I need more to prevent homelessness for my family. Thankfully I have a VERY robust investing/trading strategy that works through almost all market conditions.
Petrish @ Debt Free Martini says
I have to be honest….I do invest but it still scares me. For years I did look at investing was taking a gamble with your money. Thank God for financial education to steer that myth away.
I don’t think anyone ever feels totally secure when it comes to up-fronting thousands of dollars. I still pray that 2008 doesn’t repeat every time I buy a new batch of stocks.
Soti Coker @ Smartmoneytree says
Investing in your financial education 1st is very important otherwise it can seem more like gambling. I reckon the worst thing anyone can do is pay someone else to do their investing for them.
Financial education is where it all starts. The more informed you are, the more you’re going to reduce your chances of just throwing away your money.
Jon @ Money Smart Guides says
When I worked for a high net worth planner, we had a chart showing just this concept – how time lessens risk with the stock market. It was interesting to see the range of possible returns shrink as the years went on. Just further proves that investing for the long-term is the strategy for success.
It is amazing how much the risk and return normalize towards a positive gain as you give it more time, even after looking at different time periods. The lesson learned: You don’t have to be a wizard when it comes to investing. You just have to use your time wisely.
By definition, Investing isn’t gambling. Gambling means that the odds are against you. When you invest, you do things that put the odds way into your favor. Things like holding stocks for long periods of time, spreading your money out over several stocks, and choosing companies that have proven themselves in the past.
By contrast, putting your money in a bank account is a sure thing. You are sure to lose your money to inflation over time since the bank will always pay 1-2% less than the rate of inflation.
I fully agree that investing is not gamling. A roulette does not have fundamentals. If you invest in a company with strong fundamentals, over the long run you will be better off than a long term gambler.
Sandra Mercier says
it’s no use throwing my money for gambling.
Good example with the two different time periods, I think this is a critical example to understand. Investing is not a short term prospect. Money should be invested with a very long time horizon. Even 25 years is a short time period. Many people will live for more than 25 years after their retirement and will be investing well before that point. An investment horizon of 50+ years is what people should be looking at.
I completely agree with writer. Investing is not gambling, its simply a business and you can start it by investing more money into your already running business. It used to be difficult in past because there was less competition but its not now. If you are reluctant to invest money then you can not beat your competitors.SMSF Investment Strategy is unique kind of investment that actually gives boast to your retire life. You will be independent and you will have money at your disposal.
Stock Market Advisory says
I agree with the point that Investing is Not Gambling. Also, any investment which is done without complete knowledge then it turns into gambling. Thanks for sharing this blog.