Why investing in stocks is a safe bet
Investing in stocks is often compared to gambling. And while certain strategies used in the stock market could resemble it, like trading penny stocks, short-term speculation and unprotected option strategies, investing is actually not gambling if done properly – and gambling is definitely not investing.
The principles of investing in stocks
Stocks, or shares in a company, represent fractional ownership in a firm, giving shareholders voting rights as well as a claim on corporate assets and earnings proportional to the number of shares owned. Share prices are then determined by the supply and demand in the market or on the stock exchange.
Investing is about being patient and seeking consistent returns over the long term, comparable to putting the money into running a business. Therefore, investing in stocks focuses on buying stocks that will perform best over a period of years.
Incomes from this type of investment include capital gains and dividends. Capital gains refer to the unrealised profit resulting from the rise of the stock price above the purchase price over time, which can be realised through the sale of shares. Dividends, meanwhile, refer to the cash or stocks paid out of the firm’s earnings or accumulated profits.
Taken from The Little Book of Common Sense Investing by John C Bogle, the graph illustrates the linkage between the compounding long-term returns generated by businesses in the US and the compounding returns in the US stock market from 1900 to 2010.
Although price fluctuations exist, these cannot erode the long-term trend that the stock market grows in tandem with the economy, where $1 grew to $39,000 in the last century.
Therefore, investors who buy and hold stocks have generally been rewarded with profit in the long term.
The nature of gambling
Gambling, on the other hand, is betting money on the outcome of an event, which involves high levels of uncertainty and randomness. It is a short-lived activity, whereby the gambler expects to reap instant gains, if any.
There are different forms of gambling, such as lotteries, fruit machines, poker and betting on racing, among others.
Casinos are widely known as lucrative businesses raking in billions of dollars in revenue each year.
Last year alone, the gross yield of the global gambling industry reached $110 billion, according to the World Casino Directory Report 2019.
Realistically, the probability of losing a bet is usually higher than that of winning.
Similarities and differences
Both investing in stocks and gambling carry risks.
Gambling, however, depends largely on chance, and where there is often a lack of detailed information to assist gamblers in decision making to mitigate those risks.
Investing in stocks allows room for investors to mitigate or prevent losses through the thorough study and analysis of a company and related information, and thus the risk associated with investment.
Understanding the fundamentals that make up the value of the company is the key in making investment decisions.
When investing in stocks, you own part of the company. you can then adjust your investment strategies accord-ing to the economic cycle of the company or market. When the stock price drops below the purchase price, you can sell the stocks and retain the remaining capital.
however, there is no such long-term process when you gamble. You own no assets and receive no dividends or capital gains, and hence risk losing everything that you put on the bet.
It is inevitable that there exist certain investors in the stock markets who speculate and behave like gamblers, but that does not affect the performance of the stocks in the long term.
As evidenced previously, the divergence from the fundamentals will ultimately return to a fair price.