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What is Gambling?

Gambling is typically defined as a game of chance for money.

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There are two elements encapsulated within this definition: chance, and money. There are two or more possible outcomes, and none of these outcomes are certain.

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Both elements are necessary for an activity to qualify as gambling. Without the element of the chance for financial loss, an activity isn’t gambling. For example, we do not consider raffles at company functions as a form of gambling. Neither do we see a game of Snakes & Ladders as gambling even though it involves chance when the players roll the die.

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What is Investing?

Investing is an activity involving the commitment of money aimed at financial gain. It involves the buying and selling of assets so that through the appreciation or depreciation of price, financial gains can be realised. It also involves the holding or renting of assets to earn an interest, rental or dividend.

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It carries with it the possibility of gain or loss. Businesses may succeed or fail, carrying the prices of their stocks up or down in the process; commodities may be in high demand or be in oversupply; loans may be paid back in full and with interest, or fall into default if the borrowers can’t pay.

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Key Differences Between Investing and Gambling

Investing and gambling are similar in that both involve chance and money. They overlap in many other ways. Diagrammatically, the two concepts appear like this:

If you can make a profit by taking a chance, why should it matter whether we call it investing or gambling? At its core, the concern is a moral one.

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Investing is permissible and beneficial. It is arguably necessary for our financial wellbeing. Gambling on the other hand is morally suspect, potentially harmful and unnecessary for our financial wellbeing.

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Distinguishing Investing from Gambling

Behaviour with Respect to Risk

Because a greedy person has his attention affixed on the possibility of financial gain, his awareness of risk becomes diminished.

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He forgets that there is a chance of loss. And because of his tunnel vision, he neglects to prepare himself for the possibility of loss. He overstretches himself and displays aggressive risk-taking behaviour. If things fall out of favour, he will find himself unable to bear the loss.

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Taken as a whole, his actions are imprudent. He seeks the possibility of substantial gain at the price of substantial loss. In this way, he acts foolishly.

Odds

Consider various forms of organised gambling, such as casinos, lotteries and sports betting. As a whole, the house always wins. Not because they cheat, but because the odds are skewed in their favour.

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In French-styled roulette, there are 37 spaces the roulette ball can land on. A gambler who places a chip on the winning number receives a payout of 35 times his bet. This gives the house an edge of one thirty-seventh. Over the course of many bets, the Law of Averages guarantees the house a profit and the gambler a loss.

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In a similar manner, other forms of gambling see the house taking in more than it pays out.

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Gambling is engaging in an activity with zero or negative expected returns in search of financial gain. Over the long run, the gambler is guaranteed a loss. Yet he hopes for financial gain. The only way for that to occur is if chance favours him at that instant.

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An investor on the other hand commits his money only when he is sure that he is likely to make a positive return on his investments.

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Research & Systematic Approach

Investing requires proper research to discover what works and what doesn’t, and to discover new areas of possibility. That knowledge has to be translated into a strategy, which is systematically implemented in order to reap a financial gain.

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Gambling occurs sometimes as mindless activity in which gamblers take a blind chance in the hope of making a quick buck. Gamblers bet on the roll of the dice, or on the location a ball will land in a spinning wheel. At other times, it is a mix of chance and skill. An adept blackjack player may decide to hit or stand systematically based on well-researched probabilities of getting the best hand given the cards on the table.

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Here, proper research culminating in a systematic approach does not on its own render an activity as being one of investing. The lack of it, however, places an activity squarely within the realm of gambling.

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Sustainable Cash Flow Generating Mechanism

In its most basic and common form, investing involves buying into businesses that generate a return for its shareholders. It is much like setting up an running a business, only that instead of owning the entire business, you own a part. Investing also commonly occurs in the form of lending money to businesses to aid the expansion or operations and receiving interest payments in return.

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Behind the return you receive is a cash flow generating mechanism – the business. It either takes a bunch of resources, creates a product and sells it for a profit, or it organises people in order to deliver a service. The business activity generates the returns required to pay the shareholders and creditors.

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Not so for gambling. Gambling simply shifts money around from winners to losers. In the case of organised gambling, the house takes a cut, and gamblers lose on average.

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As soon as there exists a cash flow generating mechanism that accounts for the returns, the activity lies comfortably within the realm of investing and outside the realm of gambling. That said, it is still possible to misuse such an activity for the purpose of gambling.

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Conclusion: Investing vs Gambling

Investing and gambling are distinct to a certain extent, but see some overlaps. If we arrange the factors that allow us to distinguish investing from gambling, we will arrive at the following flow chart:

With this decision tree in place, we can test various cases against our intuitions:

As it appears to me, the results are reflective of what I would intuitively classify as gambling and investing. It also properly accounts for cases that are in the grey area, which fall in the space where the two blend into one another.

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There are several considerations that appear to distinguish between investing and gambling, including whether the activity is optional, is part of a long-term plan, involves ownership of something tangible, is time-bound, has the potential for addiction, or has positive economic effects. A close examination will reveal that these are just tangential.

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Variations of Investing vs Gambling

With the flow chart in place, we can tackle variations of the question. The holding assumptions in answering the questions will be that the odds are in your favour, that you have a well-researched systematic approach, and are prudent with respect to risk.

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Is Investing in the Stock Market Gambling?

Investing in stocks typically takes into account the fundamentals of the company, evaluates the strength of the business and considers whether it has a sustainable cash flow generating mechanism. It is not gambling.

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Is Stock Trading Gambling?

Stock trading spans the grey area and the safe zone of investing.

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Where a particular stock trading activity lies depends on whether there is an underlying sustainable cash flow generating mechanism driving the price gains. Based on the flow chart, shorting a stock will never fall within the realm of investing.

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Is Forex Trading Gambling?

Exchange rates are driven by fundamental processes such as interest rates and trade balances. These fundamental processes form the mechanism which drive price changes.

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Forex trading typically occurs on a short time frame, for which scant basis can be found in fundamental processes. Unless a forex trader makes his decisions based on a longer-term view, forex trading typically lies in the grey area.

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Is Options Trading Gambling?

An option is a derivative which gives the buyer the right to call or put a particular asset at the strike price, and which creates an obligation on the seller to sell or buy that asset if the buyer chooses to exercise it. It carries an expiration date, after which it becomes worthless.

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While option price changes may be driven by the same processes that drive price changes in the underlying assets, options do not entail direct participation in the underlying asset. They are really side line agreements between option buyers and sellers. Hence, options trading lies in the grey area.

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What is the Difference between Investment and Speculation?

In seeking profits, speculation employs similar tools and techniques to investing. It describes the grey area that lies closer to investing, with the chief difference being a lack of a sustainable cash flow generating mechanism.

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What is the Difference between Trading and Gambling?

The difference between trading and gambling is that the odds are in your favour, you have a well-researched systematic approach, and you are prudent with respect to risk.

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Is Investing Worth It?

Investing is a powerful means of growing your assets. Except under extreme circumstances such as a severe lack of capital, a limited lifespan, or severe social and political instability, investing is worth the effort.

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A good steward avoids gambling under the guise of investing by enlisting the help of his investment record, which serves as a checklist to evaluate his decision before pulling the trigger. A free template is available in the Resources section.

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