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How to avoid gambling

David James |  11 May 2015  |  Portfolio

CasinoMany think that investment is a bit like gambling. The language indicates this: words like "bets" and "punts" are often used. But think this through. Everyone knows that trying to beat the “house” does not usually work. So why take this approach?


The much better method is to become the "house" by not moving in and out of the market. Often, the best bet is not to make a bet at all. Especially when it is reasonable to assume that nobody can really predict where the markets are going.

It is clear that creating a diversified share portfolio and holding on to it for a long time is a pretty decent strategy. This is the opposite of gambling. It is in effect, saying, “I don’t want to play this game of poker, I will just sit here and take the ups and downs.”

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Many investors who see the markets as a casino say: “I will just leave my money in cash because I don’t trust financial institutions. I don’t trust corporations. I don’t trust corporate governance.”

It is not a good solution for the individual. To give an idea of the consequences, if you invested in the S&P 500 index on January 1, 1970 then by December 31, 2009, just a year after one of the worst financial crises in history, it would have been worth $43,119. If you had invested in one month US Treasury bills over the same period, the $1,000 would only be worth $10,176.

And we all know what staying in cash now means in the Australian market, where the cash rate is at an historical low of 2%.

In other words, seeing investment as a matter of luck penalises both pessimists and optimists. The optimist goes in and out of the market, generally ending up with a much poorer return than the market average. The pessimist stays out of the market, thinking it is just for gamblers, instead choosing the no risk alternative of fixed interest. This may be low risk, but it also ensures a low return. In Australia currently, interest rates on government bonds are below inflation, so investors are going backwards.

The sound conclusion is in between: assuming that the market has its ups and downs, but that investing is not a matter of luck in picking those fluctuations. Instead, it is best to avoid making bets and just stick to a consistent strategy. That way you won’t be able to “beat the house” but you will be able to be the house.

 


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