Are you Gambling or Investing?

We’ve all heard the old adage that investing in the market is the same thing as gambling. With America’s #1 wagering event, the Super Bowl, still fresh in our memories, it seems like a good time to take a look at the truth behind that statement.

According to mint.com, $87.5 million worth of legal bets were placed at Nevada sports books on last year’s Super Bowl. That sounds like a lot, until you read the next line. Legal wagering accounts for only 1% to 1.5% of all the gambling done on the big game. Do a little math and you’ll find that an estimated $8.6 billion was wagered on the Super Bowl last year, and that only accounts for gamblers in the United States.

Obviously the Super Bowl generates a lot of betting action.  According to Pregame.com writer RJ Bell, over 50% of Americans bet on the Super Bowl.  A Gallup survey taken in 2011 discovered that 54% of Americans own stocks.  The numbers are strikingly similar.  The problem is that most investment advisors and individual investors approach both activities in the same fashion.  There are stark differences, however.

The biggest difference is asset ownership. Many people forget that when buying stock in a company you’re not only asserting your opinion that the value of that company will rise, but also taking a partial ownership of the assets of that company.  The money that you invest is equal to a piece of those assets.  You are a part owner in their land, buildings, equipment, inventories and have a right to part of their profits in the future.  Try explaining to Steve Bisciotti how the $1000 bet you made on the Ravens at +3.5 should have gotten you a seat in the owner’s box when the big show was in the Superdome.

Stock ownership can be tremendously financially rewarding when approached from a non-gambling mindset, so why do so many people approach it improperly?  One reason has to do with how our brains are wired.   “Neurological similarities between traders and gamblers are striking. Whether they are about to make a trade or plunking down a bet,” said Maggie Baker, a clinical psychologist interviewed by the Wall Street Journal, “the pleasure center in the brain lights up.” So, it feels good to bet, but it can feel just as good to invest. The trick is making sure that you or your fund manager are actually investing smart, and not just using the market as a surrogate sports book.

Numerous academic studies have identified three indications that you may be doing more gambling than investing with your portfolio.

• Stock Picking – Trying to figure out which companies in a market segment will outperform their peers.
• Market Timing – Trying to change your investments based on gut feelings or where you think things are headed.
• Track Record Investing – Hanging your future on a fund or investment manager’s past performance versus the area of the market that they follow, is unwise.  Studies reveal that investing based on how well someone has done in the past almost always leads to lower returns and greater risk.

How do you find out if these things are going on?  Look at fund turnover rates.  The average mutual fund turns over about 50% of the portfolio each year.  That is far too often.  The amount that is appropriate depends on the area of the market being captured (which is beyond the scope of this blog).  Another thing to watch for is fund changes.  Advisors or investors who often change funds are making a tacit admission that they made a mistake when they bought the fund being replaced.  In my experience is it almost ALWAYS because they chased a hot manager that went cold or a trendy asset class.  The professional community is, far too often, taught to sell based on ratings services.  Unfortunately, that is like choosing lottery numbers based on last week’s winning numbers.

Investors get the same high that gamblers do when they make changes in their portfolios due to the news of the day.  They are often under the delusion that they are protecting themselves or taking advantage of economic events before they affect stock markets.  There are changes that should take place in an investment mix, but they are gradual and should NEVER be due to anything other than time horizon and issues directly related to your financial circumstances.  By avoiding the Wall Street gambling mentality, one day, instead of just planning a party, you’ll have enough money to buy your own ticket to the Super Bowl.