The Navigoe Blog

Hey CNNMoney, investing isn't a game and it's not placing a bet

Scrolling through my Facebook news feed the other night, I came across a story by CNNMoney. The teaser reads, “If you’re planning to get in on the investing game, place your bets carefully.” I must have “liked” a few CNNMoney articles recently because it seems like they are beginning to dominate my news feed.

CNNMoney Facebook Screenshot

It linked to a story with the headline: Six Stocks Wall Street is Betting Will Tank. It’s a sensationalistic enough headline that I’m not sure they needed to juice up the teaser even more. The problem with the teaser is that investing isn’t a game, and investing isn’t the same as “placing bets.”

I can understand the confusion. The way that most people approach investing unfortunately resembles a game and maybe even the placing of bets. Active trading decisions such as market timing, sector rotation strategies, stock picking, or the topic of the CNNMoney article, shorting stocks are speculative strategies which resemble a game or the act of placing a bet.

In fact, the comparison of investing to gambling is a common one. After all, both involve the risk of capital for the opportunity (hope) of a gain. However, there are key differences:

Zero Sum?
Gambling is a zero sum game. Let’s say you step up to a roulette table and place $20 on black. The wheel is spun and in a drama filled click, click, click the ball lands on a number (with an associated color). If the ball lands on black, you win $20, and the house loses $20. If it lands on something other than black (red or green), you lose $20, and the house wins $20.

The same thing happens when you bet on your alma mater’s basketball team to win the NCAA tournament, pull the slot machine arm, bet on a trifecta, or bet on “eights the hard way.” If you win your bet, the house loses the same amount. Sure there are games like poker, where you are playing against other players. It’s still a zero-sum game. The amount won is equal to the amount lost (minus the house’s take).

Investing, on the other hand, is a positive sum game. If I buy a stock or a portfolio of stocks, my winning is not dependent on someone else losing. We can all win, and over time, that is exactly what has happened. Stock markets, both domestic and international, have generated positive returns for investors who have remained invested through the ups and downs of short term volatility. There’s a reason for this.

The global stock market represents the companies, all around the world, that provide the goods and services that we, as consumers buy everyday. Through centuries of war, famine, drought, and natural disasters, global economic growth has trended upward. Certainly not every year, and not even every decade. Expanding consumer populations, increasing specialization, and improved productivity through technology and innovation have contributed to the historical upward trend in global economic production.

Of course, how you invest matters. Nobel Laureate, Eugene Fama, describes active investing as a zero sum game. “If some active manager is smart and is winning, there is some other active manager who is using the opposite weighting and is losing,” Fama has said. “Active management, in total, has to be a zero sum game. After cost, it’s a big negative.”

The part that is not made clear is that Fama is saying that it is a zero sum game relative to the benchmark or aggregate market performance. This Vanguard UK document states this point more clearly, “Investment markets are effectively a zero-sum game, with every outperforming pound being balanced by a pound that lags the benchmark.”

This means if the benchmark has a return of 8%, the aggregate performance of active managers will be 8% (before costs). A better way of stating it might be that active management is a benchmark sum game.

Time: game ending or on your side?
The Super Bowl winner is crowned, the dice is rolled, the dealer’s card is flipped, the slot machine wheels stop spinning. These events signify the end of the gamble. Either you won or you lost. Conversely, time is on the long term investor’s side. On a daily basis, investing in stocks is a risky proposition. Your investment might go up or down, and by varying magnitudes. However, as your investment time period increases, your risk is reduced.

For example, we looked at the historical returns of the S&P 500 going back to 1926, and how the range of returns was affected over different lengths of time. The way that we look at this is rolling returns using monthly data. In other words, analysis of one year periods is not only January to December calendar years, but all 12 month periods in between, such as February to January, March to February, etc.

The chart below (click to enlarge) shows the rolling 12, 36 and 60 month periods. We see that the best return for any 12 month period was an astounding 162.88%, while the worst 12 month return was a devastating loss of 67.57%. The range of returns narrows when you look at 36 and and 60 month periods.

Best Worst Returns Short Term Results

The same analysis for longer term periods yields some insightful results. Over investment periods of 10 years, the best return was 21.43%. Certainly less impressive than the 162.88% return achieved in the best 12 month period. However, the worst return was a much smaller loss of 4.95%. Over 20 year periods, there was not a single instance in which the S&P lost money. The worst 20 year period still produced an annualized gain of 1.89%. Even more remarkable, over periods of 30 years, the worst return was an annualized gain of 7.80%.

Best Worst Returns Long Term Results

While gambling is time constrained, investing is a long term endeavor, over which time your risk is generally reduced as your time lengthens.

Why does it matter?

Whether we call it investing or gambling might not seem important. Perhaps it’s just semantics. My issue is really the CNNMoney Facebook post, “If you’re planning to get in on the investing game, place your bets carefully.” In a subtle way, it suggests to the average consumer, casual investor, or Facebook user that investing is a game, a form of betting. Timing markets by selling high and buying low, placing bets on stocks by picking winners or shorting losers. Gambling. By doing so, it encourages a speculative approach to investing, which is harmful to its readers.