In April 2019, The New York Times alerted us to the danger of overconfidence when investing. The paper quoted Mark Fonville, president of Covenant Wealth Advisors. He explained that many higher net-worth clients approaching retirement will try to carry with them the spirit of risk-taking that may have brought them success in their business. This can quickly lead to something he calls an “overconfidence bias” and an investing approach that is more like gambling than wealth management.
Unfortunately, when older investors fall prey to this, they can put the “retirement” they expect in serious peril.
We’d like to further push this conclusion and suggest that any age group can also fall into the gambling trap. After all, the “stock market mindset” is pushed as THE way to build wealth, when in fact it takes a lot of risks (which doesn’t equal reward) to gamble in the stock market. COVID-19 has added fuel to the fire, as many younger investors have taken advantage of lower prices in the stock market. Due to inexperience and a lack of capital, young investors are likely taking more risks than they should.
Is Investing Just Gambling?
In truth, it depends on your approach and your investments. If you’re doing it “right,” your investments shouldn’t be a gamble. Although the common understanding of investments often leads to gambling. Let’s unpack the difference.
Tom Murkco, the CEO of Investor-Guide.com, published an essay 20 years ago that remains just as relevant and helpful today as it was back then. He set out several differences between investing and gambling. We’ve compiled them below:
When someone invests…
- sufficient research has been conducted;
- the odds are favorable;
- the behavior is risk-averse;
- a systematic approach is being taken;
- emotions such as greed and fear play no role;
- the activity is ongoing and done as part of a long-term plan;
- the activity is not motivated solely by entertainment or compulsion;
- ownership of something tangible is involved;
- a net positive economic effect results.
When someone gambles…
- little or no research has been conducted;
- the odds are unfavorable;
- the behavior is risk-seeking;
- an unsystematic approach is being taken;
- emotions such as greed and fear play a role;
- the activity is a discrete event or series of discrete events not done as part of a long-term plan;
- the activity is significantly motivated by entertainment or compulsion;
- ownership of something tangible is not involved;
- no net economic effect results.
When defined in this way, it’s easy to see the differences between investing and gambling. It’s also easy to see that because of the vehicles some people use to invest, their behavior may more closely resemble gambling.
That is why it’s crucial to examine both personal investment behavior and the vehicle for investment before making a deal.
Industry studies have repeatedly shown that the behavior of mutual fund investors often accounts for poor investment performance. This is because they often don’t approach investing systematically, and emotions like greed and fear may cause people to make impulsive decisions, with little or no research. Not surprisingly, the results from these methods more often resemble the returns from lottery tickets.
Not Gambling with Your Investments: Easier Said than Done?
In his book, Snap Judgment: When to Trust Your Instincts, When to Ignore Them, and How to Avoid Making Big Mistakes With Your Money, author David Adler says the psychological component of investing is the most difficult to manage. Adler contends that behavioral research shows many individuals have an almost overwhelming set of hard-wired dispositions to take gambles rather than make investments.
Adler quotes Andrew Lo, an MIT professor of finance:
“The same neural circuitry that responds to cocaine, food, and sex has been shown to be activated by monetary gain as well.”
For some people, the thrill of investing/gambling can be addictive. You must remember, however, how important it is to prioritize your financial well-being and big-picture dreams, rather than seeking a financial thrill. Don’t sacrifice the things that will matter most to you, especially if you’re risking money that’s meant for retirement, education, or making memories with your loved ones.
This imperative to not compromise investing by gambling highlights one of the greatest benefits of working with a team of financial professionals: Besides receiving informed advice, a financial professional can often serve as a protection against gambling with your investments, by encouraging you to make sound decisions based on good research that have a high likelihood of success.
Take a moment to consider the last few major financial decisions you’ve made in the past year. Then look at the list above. Did you make an investment or take a gamble? If you’re interested in acquiring liquid assets without gambling, contact us today to see how we can help. We’d be happy to help you create more certainty, flexibility, and freedom in your financial picture. Email us at welcome@ProsperityThinkers.comm.