by Daniel Yu, CFAÂ®, AIFÂ®, REDW Stanley Financial Advisors
Perhaps one of the most common comparisons is the one comparing investing to gambling. The similarities are undeniable. You can lose all your money or end up with a great deal of money. Even the indicators of success and language are similar. We talk about being up or being down, being in the red or being in the black, the big loss or the big win. Both utilize statistics and we talk about the odds of certain outcomes. However, there are major, fundamental differences that we will explore.
Think of friends at poker night. Each one pays into a pot which is then eventually won by a single winner. This is what is meant by gambling being a zero sum game. Some win because others lose. Now, think of a casino. The bright lights, the excitement, the opulence all contribute to the mystique of quick wealth. But in the back of our minds we remember, â€œThe House always wins.â€ The Casino is a zero-sum game with a bright, shiny wrapper.
Now consider the media portrayal of investing. Usually, we see a trading floor with excited traders yelling out orders, or in todayâ€™s world of electronic trading, they are intently entering in orders on tablet computers. Also, the news reports the biggest gainers and losers, which company has tripled in value or fallen below a key price indicator. Occasionally, we hear of a company â€œgoing under.â€ Of course, there are the stories of the mega-wealthy investment bankers who â€œrig the gameâ€ to take advantage of people. Wall Street is the shiny wrapper to an age old process of raising capital for new economic activities.
Investing takes advantage of the ability of people to allocate their resources individually. Think of two family members who decide to open a restaurant together. They both put in time, money, and hard work to make the restaurant a success. Was it a gamble? In some ways, yes. Success was not guaranteed, and failure was definitely possible. However, the restaurant (or any business) is not a zero sum game. It was an endeavor in which real wealth and value is created.
As businesses succeed and seek to grow or expand, they have three basic ways of doing so: internal financing, debt financing, and equity financing. With internal financing, the owners use the profits of the business to fund their expansion. With debt financing, owners go to a bank or in the case of larger companies, they will issue bonds to raise the necessary funds. With equity financing, capital is exchanged for a share of the future profits of the firm. The capital markets are the next extension of this logic, with the debt and equity of companies being bought and sold based on the needs and perceptions of both the buyers and sellers. However, unlike gambling (a zero sum game), companies use the money raised in the capital markets to finance facility expansion, new services, new products, or product innovations. In each of these examples, new jobs get created, new products are created, and overall the standard of living improves.
Of course, competition exists in the free markets, and some companies fail while others succeed (think of all the social media and internet companies that no longer exist). But on the whole the economy grows and society is better off. So, the next time you are tempted to think of investing as just gambling, remember you are taking part in a grand dynamic that has expanded economies in the US and elsewhere, and helped raise the standard of living for generations. Of course, we are here to help you navigate these issues as you pursue your own financial goals. Please call your Relationship Manager if you have any questions.
Copyright 2017 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice.