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Nearly 130 million Americans watched last year’s relatively boring Super Bowl in which my Philadelphia Eagles throttled the Kansas City Chiefs.
One reason so many may have stayed interested in the blowout was that Americans bet an estimated $1.4 billion on the contest. Of course, anyone who took the Chiefs may have lost interest by halftime.
What may be lost in the entertainment of sports betting is the parallels to how financial markets work. Both industries channel a vast number of opinions into wagers that are hard to win consistently.
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At the same time, there are important distinctions between gambling and investing. Grasping the fundamental differences between the two can protect investors from chasing fads.
Gambling, especially when you win, can be fun. But the keys to a successful financial future are rooted in principles like patience and diligence.
Trust markets
An important function of competitive markets is driving prices to equilibrium. This refers to a state where demand is balanced on both sides of a trade.
When two teams face off, it’s usually not an equal contest. One team is typically favored to win, perhaps because they have more-talented players or fewer injuries or will be playing in front of their home crowd. One way to induce gamblers to bet on the weaker squad is to lower the “price.”
This is accomplished by a point spread indicating essentially how much the underdog can lose by and still be considered a winner for betting purposes.
A similar dynamic occurs in investing.
Every trader who thinks the price of a stock is high is offset by one who thinks the price is low. So, they agree to transact, voluntarily, at the current price. If there is insufficient interest in buying, the price must fall until a new equilibrium is reached.
Both markets are information-digesting machines. That’s why they’re so hard to beat. Research on NFL and NBA games shows favorites win about half the time — consistent with a coin flip you’d expect if no side had an edge.
And decades of academic research on financial markets demonstrate that stock pickers can’t consistently outperform their benchmarks — just what you’d expect if market prices are fair.
The house always wins
While the gambling and investing markets work in a similar manner, the activities themselves should be separated. That’s because one has a positive expected return, and the other does not.
Stock market investors, for example, have a positive expected return as compensation for bearing the risk of equity markets. The U.S. stock market has returned, on average, about 10% over the past century.
Investors don’t have to pick which stocks will do well to have a positive investing experience. They don’t have to beat the market. A diversified, low-cost ETF or mutual fund that invests in the stocks of a broad range of companies may do just fine in a full market cycle.
Moreover, the stock market is forward-looking and reflects optimism in the prospect of people coming together to solve problems and improve lives. Stocks rise over the long term, to investors’ benefit, because companies continue to churn out profits.
But gambling? How many of us expect to leave Las Vegas with more money in our pockets? Vegas casinos and resorts weren’t built on winners. You may make money only if you get lucky — an outcome you can’t count on. It’s a zero-sum game.
A dollar bet is a dollar you likely should expect to lose.
Investing can be, and likely should be, boring
In the past few years, financial product launches have provided investors with tools to gamble or otherwise take more risk within financial markets. Whether it’s leveraged single-stock ETFs or cryptocurrencies, it’s never been easier to “wager” on market predictions.
But while these speculative vehicles make investing feel more exciting, they could derail an investor’s progress in the end.
When it comes to your nest egg, luck may not be a strategy you want to count on.
