What’s the Difference Between Gambling and Investing?

The best starting cards in Texas Hold’em — the world’s most popular version of poker — are A-A. Two aces. They’re affectionately known as “pocket rockets,” or as my friend likes to call them: “KLCC Twin Towers.”

The worst starting cards are 7-2 offsuit — where you get one 7 and one 2, with both cards from different suits (“flower” in Asian terms). An example of 7-2 offsuit is 7 of Hearts + 2 of Spades.

In standard poker strategy, you would fold 7-2 offsuit — meaning you give up whatever money you’ve already put in, and stop playing that round. Get A-A on the other hand, and you would raise — meaning bet more money. In fact, players often bet all their money when they have A-A.

This is the dramatic moment in movies when someone shoves all their chips into the middle of the table and says: “ALL-IN.”

What would happen if 7-2o decided to foolishly play against A-A all-in? As you might expect, A-A wins.

Usually.

What you might not expect, is how often 7-2o wins: ~12% of the time.

Welcome to the wonderful world of poker: Where even the strongest cards played perfectly against the weakest cards will lose roughly 1 out of every 10 times.

There’s Always a Chance

What’s the difference between gambling and investing?

If you say gambling has the element of chance, well actually — everything has the element of chance.

Consider Malaysia’s tourism industry, the third largest contributor to the nation’s economy (GDP). In December 2019, everything seemed rosy. Tourism numbers had been growing steadily over the past decade.

2020 was even declared as Visit Malaysia Year — targeting 30 million tourists and RM 100 billion of income.

If you could somehow invest into the broad Malaysian tourism industry in December 2019, nobody would have accused you of being reckless with money — let alone say you were gambling.

Yet, COVID-19 happened. 2020 happened.

The results have been terrifying. Till September 2020, only 4.29 million tourists had arrived. Tourism income dropped by 80.9%. And who hasn’t heard of a friend who recently lost their job or faced a pay cut?

What’s the probability of the third-largest industry of an entire country — with all the right elements to be a tourist paradise — getting decimated by a global pandemic? Once in a hundred years maybe?

The lesson here isn’t to avoid risk. The lesson is risk is unavoidable.

The Spectrum of Risk

Is it a matter of degrees of certainty?

If you play perfectly in poker (A-A vs 7-2o) and still lose 12% of the time, you might say we’ve crossed into gambling territory. Whereas you can invest in many other assets which are historically less risky.

Ben Carlson recently wrote a brilliant piece about how the longer you invest in the broad USA stock market, the better your odds (remember, no guarantees). Since 1926, if you had invested in the S&P 500 for at least 20 years, you would have been profitable 100% of the time.

Here’s Ben:

“The longer you play in a casino, the greater the odds you’ll walk away a loser because the house wins based on pure probability. It’s just the opposite in the stock market.”

Of course, despite their stellar performance, stocks aren’t everyone’s cup of tea. Someone else might prefer the safety of fixed deposits, where if you had held for at least one month, you would have been profitable 100% of the time.

What if I applied the same methodology to everyone’s favorite speculative asset of recent times, Bitcoin?

You might be surprised that for all its infamous volatility, if you’d bought and held Bitcoin for at least three years, you would have also been profitable 100% of the time.

Nobody sane would say Bitcoin is “safer” than the S&P 500 though. Because assessing investments is not just about the probability of losing money over time. It’s not just about the choice of asset (e.g. stocks vs property vs crypto) either.

For the most part, it’s about whether you understand what you’re investing in.

Knowing What You Don’t Know

In January 2021, a group of anonymous traders on Reddit took on a group of Wall Street hedge funds at a game of high-stakes betting in the stock market (re: GameStop saga). Popular narrative says the Reddit traders1 won.

The Wall Street “bad guys” lost billions of dollars. People around the world cheered that David had defeated Goliath.

Inspired by these events, another group of traders proposed another coordinated “Buy and Hold” — this time for the cryptocurrency XRP (commonly called Ripple). The target date: 1st February 2021, 8:30 a.m.

The XRP price surged. It went up almost 300% in the week before 1st February. And then at 6 a.m., 2.5 hours before people were supposed to buy together, the price started dropping. Right on cue at 8:30 a.m., it crashed.

XRP’s price lost 49% on that day — leaving buyers who’d hoped for quick riches in tears. I’m fairly certain now the coordinated “Buy and Hold” was actually assholes pulling off a pump and dump.

Two stories, wildly different. But from questions I was being asked right before 1st Feb, I realize many people actually thought the GameStop and XRP situations were very similar.

Perhaps the organizers purposely misrepresented it as the same thing — large groups of common people FIGHTING against the establishment.

But in GameStop, the opponents were (supposedly) evil hedge funds. In XRP, the “opponents” were actually their fellow investors.

It was a very different situation, but you might not have realized it unless you have experience trading.

Gambling is when you don’t know what you’re doing with your money, but still hope to profit.

Growing in Uncertainty

“That’s a bit judgmental isn’t it?”

True. If everybody waited until they had perfect knowledge before doing anything, the world would fall apart. Who can claim they’ve 100% mastered the mysteries of investing?

Surely there’s a way to invest/gamble — whichever way you call it — in things you don’t fully understand yet. Without too much risk.

I like to call that “experiment money.” Money you can use to explore and learn, but won’t cripple you even if you lose everything.

For most people, this would be extra money after they’ve paid off all necessities, built up emergency savings, and invested in some conservative assets.

Personal example: for all my belief in Bitcoin, I’ve only ever invested less than 10% of my net worth into it. My initial purchase was small.

But that small start incentivized me to learn much more through first-hand experience — eventually leading to a full-time job I love today.

Sizing your bets is important. Choosing a good mix of assets is also important. But what’s most important is you continue to learn and grow.

Investing is learning from the past and betting on the future.

Finding Balance With Boundaries

Can gambling and investing co-exist? I think so — as much as I like investing, I also love playing poker2. But the boundaries must be clear.

(Don’t worry Mom, most times I play using fake money.)

And even when I’m gambling during Chinese New Year with real money, we keep the amounts reasonable.

You could say I’ve found balance — significant time for investing, and just a bit of play time for gambling. Significant money for investing, and just a bit of play money for gambling. I will never let these two buckets of money meet.

It works for me. My investments keep me financially stable. Meanwhile poker allows me to share meaningful time with friends, while helping me practice probabilistic thinking — a good skill for investors.

I hope you’ll find your balance too. What you’ll invest in. What little you’re willing to gamble3 if you can bear the risk. And where to draw the line.

And if you’ve made it here and are still confused about the difference, here’s two final statements to help:

  • Trying to get rich quickly — within weeks or months — usually leads to losing money quickly.
  • If you’re not sure if you’re actually gambling or investing, you’re probably gambling.

Play safe.

 

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Footnotes

1. There’s emerging evidence suggesting the GameStop saga wasn’t as clear cut as Hedge Funds vs retail traders. In fact, many large institutions made big money as well.

2. Unlike some other common games, Texas Hold’em poker is a game of both luck and skill — kinda like real life. Over the long run, I would say it’s more skill than luck.

3. I’m aware that for many people, gambling is addictive and can destroy entire families. If you struggle to draw boundaries here, please stay away completely.

 

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Pic from Pexels: fotografierende


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5 comments

  • I read this quote somewhere that I agree with, that investing is not a study of finance, but a study of how people behave with money.

    IMHO there is not much difference between gambling and investing, when one doesn’t have control in making business decisions.

    Strong fundamentals can easily be brought down by market changes, weak leadership, bad business decisions. We have seen this often enough in covid times. The market fluctuations are controlled by the big players. Retail investors are just playing to the up-down cycle, regardless for short term or long term, as they have no control over the business directions.

    Taking your example of Bitcoin 100% profit after holding out for 3 years, I could very well imagine the extreme of 0% as well. One could constantly monitor the market for ups and downs, but the time spent doing so is precious and is not considered passive investing anymore.

    I invest with experiment money, when there is a profit, we celebrate with a good meal and eye the next potential stock. Will never get rich this way, but more for the fun and thrill of getting a win.

    • Thanks for sharing. Appreciate it.

      I believe that quote is from Morgan Housel. An amazing one for sure 😀

  • Interesting. I’ve always portrayed the market as fundamentals + sentiment.
    The description of gambling can convey misunderstandings to an amateur investor about the nature of investments and the capital market.
    Some investors until this day still believes there is a conspiracy behind every stockmarket moves against them. I think they might forever see the noise and miss the signal.
    (The fundamentals being the signal, the sentiment being the noise.
    Population + Productivity + Technology growth = long term signal
    Volatility = short term noise)

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