The Betting Analogy Delusion

There is a common view that “Investing in shares is like betting on the horses”.

This is wrong. When you buy shares to invest you are buying a part ownership in the horse, not betting on just one race.

To push this analogy to the limit: If you choose to buy part ownership of a good horse it will win more than the average horse and therefor be worth more. So the value of your share appreciates.

Trading rather than investing in shares is closer to gambling than investing, as you will be betting on the short term performance of the share. That is the equivalent of betting on a horse in just one race. Like with betting on horses if you study the form of the share and pick your race (the point in time) you can improve the odds. But to do this you need the time to become an expert on studying form and develop a deep insight into the particular horses (shares) you follow. And even after all this you will be subject to the whims of market volatility.

The outcome on a short term trade on a share is subject to the volatility of the market, understanding and predicting ‘that’ is not possible for most of the people most of the time. The odds of wining on a long term investment however are significantly better, because over the longer term the market price for shares has always increased and a rising tide ,on average, raises all boats.

To win at investment you need to get part ownership in more than one horse as you don’t want to end up with all your money invested in a bad horse. You need to put your money on many (15 or more seems to be the general recommendation). If you were to pick shares randomly such that some would do well and some badly, if the overall market rises over 5 to 10 years, so will your investment. If you manage through studying the form (financial performance) of your potential picks to avoid the bad bets, you should be able to do somewhat better. You can win at investing (beat the market) if 55% of your picks do well.

So investing is not like gambling because if you invest for the long term you will more likely than not profit. Whereas if you gamble in the longer term the house always wins and you alway loose.

(Photo fromĀ www.goodfreephotos.com)

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