On the other hand, if they go to a casino, then they are at least playing with their cards on the table, even if the odds are against them. It is important that people do not delude themselves about their capabilities or what they are risking.
There are various things that stock-picking investors need to understand and often do not, especially if they are amateurs. It is these aspects that also differentiate gambling from investment. Furthermore, they apply to both successful investing and stock-market gambling.
Investing is not a casino game
The main difference between the two is the level of acceptable risk and willingness to speculate. Investing requires prudence and a degree of risk aversion, whereas gambling suggests dispensing with such caution. But both want to do well and earn money.
Some of the fundamentals are as follows.
In contrast to funds and exchange-traded funds, individual shares entail an additional risk. Every company is affected by both so-called systemic and non-systemic risk. The former relates to the market at a whole, and the latter to the specific company.
Accordingly, if something goes specifically wrong, the company shares can plummet, while the market as a whole remains unaffected. Bad managerial decisions, supply-chain problems and a host of other problems play their part.
If, for example, you have 15 shares in your portfolio, you really need to be monitoring the development of all of them, which is not easy. And the associated risks do not necessarily mean higher returns either.
Many other factors can determine whether the results are good, indifferent or disastrous. What happens at shareholder meetings, or regulatory changes, are just two more.
Another problem is that unwary investors often do not understand the economic mechanisms of underlying share-price formation. The stock market itself determines the prices, and only partly how the company itself is faring.
The typical investor error is thus thinking that as long as you know and can trust the company, you cannot go wrong.
Certainly, the optimal level of risk is the name of the investing game: not too much or too little. This point is not well understood by a lot of people, including many working in the investment industry, who ought to know better and convey more to clients.
I remember overhearing an adviser asking an elderly lady how much risk she was willing to take. “None at all” was the response, after which the adviser fortunately explained why some risk is essential.
I also know of litigation against a trustee who had left almost everything in bonds, with the result that the portfolio had performed appallingly over time, compared with a sensible combination with equities.
