Everything we do in life involves some degree of risk either it is driving a car or starting a business. But has anyone skipped any of the above-mentioned acts? In order to succeed in the above-mentioned acts, you need proper training or guidance. But once you get the right guidance you can win any game either it is starting a multi-million dollar company from a scratch or being a driver like Michael Schumacher.
Many a person has a perception that there is no difference between investment in the stock market and gambling as both involve some risk. But friends it isn’t true. In this column we will discuss why investing is not gambling and also offer you a step by step guide to the difference between investment and gambling.
What is Gambling?
Gambling is acting completely dependent on the favour of luck. In gambling, you may either win or lose. You have to accept the possibility of losing your invested amount. Sometimes the amount of risk crosses the expected reward. It can be assumed that gambling is like dividing up a fixed cake among winners and losers. In most gambling, there are some additional factors involved such as costs, fees, or odds. These things result in dividing a shrinking cake.
Some examples of gambling: Currency Trading of Futures and Options (except hedging), Commodity Futures and Options Trading (except hedging), All Lotteries, and Casino games such as cards, table games, or electronic games.
In all these gambling the odds act against you because they divide among the “winners” a smaller cake than originally exist.
What is investing?
Investing is putting the money in assets or fields that may generate income or appreciation in the future with the risk. These asset classes are expected to generate profit for investors. In most cases investing generally involves placing the money at risk for the purpose of gaining higher returns than savings.
Investing means purchasing a claim on goods or services to create wealth. You are investing means you are resorting to a way to gain wealth in the future.
Examples of Investing: Individual stocks, bonds, mutual funds, most ETFs, etc. The other mechanisms are real estate, gold bonds, rental property, buildings such as factories, office space, retail space, etc.
The gain or loss in investment depends on the performance of the asset or sector you put your money.
Difference between Investment and Gambling
We will have our discussion on the basis of investment in the stock market. People have confusion about investing and gambling. Gambling totally depends on the favour of luck. On the other hand, investment is the performance of that sector. In gambling cards or dice may act differently. You have to depend on your luck. Investment is made on a real basis. It works on practicability. Suppose you buy any stock. The concerned company will try to do business and gain profit. Similarly, in any kind of investment someone or a group of people tries to act for that money. But in the case of gambling, no one can do anything.
Without knowing the proper information about the company or stock in which you are going to invest your hard-earned money and betting at poker without looking at your cards both can be treated as a gamble.
Investment and gambling both cover some risk
“Risk comes from not knowing what you’re doing.” – Warren Buffett.
Though investment and gambling both cover some risk with them, investment is lesser risky or risk-free. Here we will discuss the risk associated with an investment in the stock market. In the case of direct equity investment, an investor needs to gather sufficient knowledge about the stock market and the stocks or shares he wants to buy.
Many investors invest in direct equity without doing proper fundamental analysis, technical analysis, qualitative analysis, balance sheet, profit and loss account, etc. and wait only for one year or two years to get satisfactory returns. Then, in most of the cases, these investors make a loss because of their lack of knowledge and proper analysis.
How to Invest intelligently
On the other hand, what intelligent investors do is that they check the fundamentals, technical, qualitative factors of stocks they want to invest and then invest accordingly. If you intend to invest via direct equity, you need to read a lot about the stock or company. Always you need to keep a close eye on the stock’s quarterly as well as annual results. You should make an investment strategy in accordance with your risk appetite and goal tenure.
Via Mutual Fund
If you invest via mutual funds, you neither need to read anything about a company nor need you to keep an eye on that company and its movement. The only thing you are to do is that just go to any Mutual fund company or a Mutual fund agent. Then the company or the agent will do all the things on behalf of you. You can start investing either via a Systematic Investment Plan or a lump sum investment. Then, the respective fund manager will invest your money in around 25-30 companies to diversify the risk. Thus, you can lessen the risk factor and generate better returns in the long term.
If you have long-term horizon you may invest in small-cap or mid-cap mutual funds which yield better returns over large-cap mutual funds. You do not need to have a cautious eye on the quarterly or annual results of the respective companies. You can pick midcap and small-cap stocks after proper analysis of a stock’s fundamental i.e. debt ratio, compounded sales growth, profit growth, P/E, Balance sheet and Profit & Loss account. Whatever, if you are unable to do anything, the fund manager will manage your investment accordingly.
Note: This is the few lessons from the book which I discovered from Tycho Press’s brilliant book ‘Stock Market Investing for Beginners‘.
Gambling is entertainment, but Investment is a business i.e. the ownership of a company
Investment is smart work. We all work hard to earn. Then from this earning some of the amounts we save. These savings can be put in some investment ways. This is what we can do for our future. If we spend these savings on entertainment through gambling we will be left with nothing.
Well, it does sound like an exaggeration, but when you put your money in a reputed company’s stocks, you become a part-owner of the company, irrespective of however smaller your share may be. You can improve your standing in the market by sagaciously putting your money in different companies. Moreover, you can exit whenever you want.
Investing is saving for specific goals such as retirement while gambling is not
Investing is a way to secure retirement life, but gambling is not. Gambling can give you pleasure on a temporary basis with the possibility of huge risk. We have various responsibilities to take so we need money for the future. Investment is an option to ensure funds for future responsibilities health hazards, education of children, daughter’s marriage, house building, etc.
You must have a clear view and a good understanding of the expenses that will be required to live after retirement. The current inflation rate is 7% per year. It means next year you will need Rs. 107/- to buy the same product you can buy now with Rs. 100/-. So if you can fulfill your requirements with Rs. 20000/- per month now, you will need Rs. 1, 52,245/- approximately per month after 30 years. Consider the case of inflation and do the needful.
How to calculate Retirement Corpus
Suppose you have started earning at the age of 25 years and your earning is Rs. 25000/- monthly. Now you wish to make an early retirement at the age of 60. So, you have got 30 years to achieve a sufficient amount in order to lead a happy and prosperous retirement life.
Your yearly salary – Rs.3, 00,000/-, assuming Rs. 25,000/- a month.
Your yearly Household Expenses – Rs. 1, 80,000/-, assuming Rs. 15,000/- a month.
Term insurance premium – Rs. 7,000/- assuming assured sum of Rs. 1 crore for a term of 30 years.
Health insurance premium – Rs. 8,000/-, assuming a cover-up to Rs. 5 lakh/ year for a term of 35 years.
Expenses on festive season = Rs. 25,000/-.
Therefore, your expected expenses throughout a year is = Rs. 1, 80,000/- + Rs. 7,000/- + Rs. 8,000/- = Rs. 25,000/- = Rs. 2, 20,000/-.
Then, the expenses at the age of 60 years assuming a current inflation rate of 7% will be = Rs. 21 lakh. [excluded term insurance premium and health insurance premium since they are fixed at the time of buying].
So, you have to accumulate a corpus of [Rs. 21 Lakh × 20 years = Rs. 4.2 Crore] at the age of 60 years, assuming you will live at least 80 years.
Let’s assume you have two kids i.e. one daughter and one son. So, the Education cost of son & daughter as well as the daughter’s marriage after 20 years = Rs. 40 Lakh.
Total amount need = Rs. 4.2 Crore + Rs. 40 Lakh = Rs. 4.6 Crore.
Investing is based on skill & research while gambling is of luck and emotion
Gambling is based on having a chance of luck. A gambler takes risk of his capital. Then a fixed amount is divided among winners and losers based on chance.
But in the case of investment for consistent returns, you should check out the following parameters of a company before investing.
- Revenue – Revenue or net sales of a company should be constant for at least 5 years. You may check that the company has been generating sales growth annually during the last 5 financial years of at least 10%.
- Net Profit – The net profit of a company increases at least 15% on a year-on-year basis.
- Earnings Per Share (EPS) – EPS is to grow at a rate of 10% for the last 5 years.
- Debt to Equity Ratio – A debt-free company is desirable. If not so the ration must be low to 0.10 or 0.25.
- Return on Equity (ROE) – should be greater than 20%
- Dividend Yield – You can ensure about good dividend yield by the company.
Valuation Of any Stock
- Price to Earnings Ratio (P/E) – P/E ratio should be low as compared to the other peer companies active in the same industry.
- Price to Book Ratio (P/B) – P/B should be low as compared to peer companies operating in the same industry.
- Beta – Invest in stocks whose Beta is less than 1 which indicates that the share is theoretically less volatile than the market.
After checking out the above-said parameters of a company or stock, you need to take into consideration the following points,
- Business model
- Future potential
- Management of the company
- Moat i.e. competitive advantage
Finally, as an investor, you provide some capital to the company by investing in it. This fund helps the company to grow its business and make a profit. Gambling of any kind does not help anyone in any way. There are no economic benefits of gambling.
How Capitalante can help you
Are you confused about how to prepare an effective financial plan to achieve financial freedom? If yes, learn how to prepare effective financial planning.
- Read also: Why People Lose Money in Stock Market
- Read also: How to Pick Best Stocks for Consistent Returns
If you have any questions regarding the difference between investment and gambling, feel free to comment so that we have a discussion. If you have found this post helpful don’t forget to share this post.