Betting vs. Investing

By Randall Coleman, Portfolio Manager, CFA

By the time you read this, Super Bowl LVIII will be history and the sports gods will have decided which team’s fans prayed the hardest. Congratulations to all you Chiefs’ fans—your prayers were answered. Or did it all come down to the coin flip that decided how the game started? Who received the first kickoff? Was that the advantage that made all the difference? It’s a game of inches, after all. A lucky break at the beginning could tip the balance, right? Did you bet on the game? Was your analysis of the strengths and weaknesses of the teams sufficient to put money on the correct team to “beat the spread” and make a positive return on your investment? Uh, sorry, make that a return on your bet? Is there a difference between betting and investing? My dad, despite my being a portfolio manager for more than 25 years, flippantly refers to buying stocks as a bet. What’s the difference between a bet and an investment, anyway?

Dictionary definitions point to the distinction:

Bets and wagers are stakes risked on an uncertain event. The participants understand this and there is no expectation that a losing bet will have any reward: you either win or you lose, a binary outcome. Investments, on the other hand, are expected to return some benefit to the investor. It is the expectation of payback in some amount that makes an investment different from a bet.

Is there more to it than that? Absolutely. Delving into some subtleties leads to some interesting findings. Let’s take a look at several considerations across different examples: ease and cost of transactions, risk/reward payoffs, and knowledge/skill level.

Example 1: The office football pool

Because it’s fresh on our minds, let’s start with the time-honored office football pool. A 10×10 grid is offered to players and each “square” is purchased for, say, $20. After all the squares are purchased, a random assignment of the digits 0 through 9 is applied to each column and row, giving each square a unique combination of digits. The two teams are assigned either the Rows or the Columns. At predetermined times in the football game, payouts are made to the owner of the square whose digits match the score of the game (only the last digit is used). In this example, payouts are made at the end of the first quarter ($250), second quarter ($500), third quarter ($250), and the final score ($750). A bonus $250 is paid to the square that has the correct final score, but with the digits reversed. The risk is low ($20 per square) and the potential win is not life changing and the skill level to participate is zero. So what’s the point? The small monetary wager increases engagement dramatically. The pool creates a layer of excitement above and separate from the simple outcome of the game. It creates an alternative goal for players to cheer for and to talk about after the dust settles. Camaraderie is an intangible benefit that football pools create. Considering examples of team building exercises that companies hire consultants for, football pools are a remarkably economical alternative.

Ease and Cost: Practically none. Risk/Reward: Low. Knowledge/Skill: Zero. Intangible benefits: High

Example 2: Baccarat

Baccarat is a casino card game with simple rules and the closest to even odds you can get at a card table. As a bettor, you pick either the “Bank” or “Player.” Betting on the Bank has a slight edge, but the casino compensates for that by taking a commission on winning Bank bets. There are no decisions to be made after your bet is placed, with cards dealt and winner determined by formula. You either win, or you lose. Because the casino will keep dealing you hands as long as you have money to bet, your potential loss is limited only to how much money you have to gamble. This is an asymmetric risk as the casino has more money than you. The casino limits its risk via table limits, or maximum bets it will allow. Each gambler’s brain chemistry is different, but a varied assortment of brain activity drives gambling behavior: dopamine rush, excitement, gambler’s high, free cocktails, the thrill of winning, instant gratification: these are the non-monetary benefits—and sources of potential harm—to the bettor.

Ease and Cost: Low. Risk/Reward: Capped by table limit. Knowledge/Skill: Low. Intangible benefits: Entertainment value

Example 3: Trading options

Options can be used to mitigate the risk of holding some other security, or they can be used to create risk, to speculate. It is the options structure, then, that determines whether they are being used to increase or decrease risk. In the case of risk mitigation, options are firmly in the investment camp, where an expected return (or a loss avoided) is implied. Purchasing a put option on a security owned limits the downside risk of that security. When used to create risk, options take on more of a bet personality. Risk and reward can go to extreme levels. Indeed, writing naked calls is the riskiest investment bet you can make, with potential losses unlimited.

Ease and Cost: High. Risk/Reward: Varies from Very High to Very Low. Knowledge/Skill: High

Example 4: Buying stocks

Investors buy shares with an expectation of price appreciation, dividend income or a combination of both. The expectation of profit fits perfectly with the definition of investment, quoted above. The level of engagement of the investor determines whether a stock purchase is a bet or an investment. The proverbial “dartboard throw” decision to buy a stock classifies as a bet. Thorough analysis and research, combined with a determination of relative valuation and intrinsic value and a thoughtful view of competitive positioning amongst a company’s peers would classify as an investment. Guessing at winners is a very different game than making well-reasoned, thoughtful decisions. It’s what distinguishes a bet from an investment.

Ease and Cost: Low. Risk/Reward: High. Knowledge/Skill: High

FactorInvestingBetting
Time horizonLong termShort term
Emotional paybackQuiet satisfactionInstant gratification
IntangiblesSecurityEntertainment

The late comedian Norm Macdonald talked about his gambling addiction, pointing out the magic moment when time stands still: “The particular moment when the dice are in the air the gambler has hope. And hope is a wonderful thing to be addicted to.” Hope is not an investment strategy. Hope is not how we construct our portfolios. Yes, of course we hope our companies do well and perform up to our expectations, but it is hard work, thoughtful research and an endless search for better alternatives that drives our investment process. We’re investors, not gamblers.

P.S. I hope you won lots of money on the Super Bowl.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.