“If you must play, decide upon three things at the start: the rules of the game, the stakes, and the quitting time.”  -Chinese Proverb

As a society we have been conditioned to believe that there is a difference between gambling and investing.  Of course, this partially true, however, the degree to which we “invest” and “gamble” is smaller than most are likely comfortable admitting.  The majority of us have been conditioned to believe that buying a share of Bank of America is vastly different from placing a bet at a roulette table.  A closer inspection of “investing” and “gambling” shows that the two are closer than the Wall Street sales machine would like you to believe.

60 Minutes aired an excellent piece this past Sunday about Billy Walters (video attached below).  Walters is a Las Vegas gambler widely acknowledged as one of the greatest gamblers Vegas has ever seen.  He’s so good that he has to bet anonymously through partners due to the fact that most casinos won’t take the other side of a bet from Walters.  The few casinos that do bet with Walters do so mainly because they want to know what he’s thinking.  But Walters isn’t truly a gambler. Walters is so good that he feels safer gambling than investing.  And ironically, it isn’t the casinos in Vegas that have taken Walters for a ride over the years, but Wall Street.  Walters claims that it is not Vegas where the thieves live, but rather the men in suits on Wall Street.

Before we can understand the difference between gambling and investing it’s best to define each.  Gambling is placing capital at risk of loss with an uncertain outcome in a system in which the odds are generally unfavorable.  Gambling has an inherently negative connotation because it is generally a term used to describe games in which the player is a guaranteed loser over the course of the game’s lifetime.  Unlike investing in equities, a bet at a casino generally has unfavorable odds.  The game is intentionally devised as such. Investing, on the other hand, is placing capital at risk of loss with an uncertain outcome in a system in which the odds are generally favorable.  The primary difference between gambling and investing is the determinability of the outcome.  The lottery for instance, is entirely unpredictable.  Purchasing government bonds has a high level of predictability.  The following diagram helps break down the gambling/investing spectrum:

So we can differentiate investing from gambling only to the extent that the outcome is predictable.  There’s obviously a vast gray area involved in determining the future outcome of anything.  As the great physicist Neils Bohr famously said:

“Prediction is very difficult, especially about the future.”

According to chaos theory, in the long-term, all outcomes in dynamical systems can ultimately be rendered unpredictable.  In the short-term, however, these systems display levels of stability that make them somewhat deterministic.  Some systems are more deterministic than others, but the outcome is always ultimately unpredictable when taken to an extreme. The lottery, for instance, is always unpredictable.  There is nothing (or very little) the player can do to alter the outcome, improve their odds or increase the predictability of the game’s result.  Buying government bonds, on the other hand, is generally considered a safe “investment” due to the high level of predictability involved in determining the outcome.  But even in this instance there is still an element of gambling.  The USA appears like a highly solvent entity (and I have argued as much ad infinitum), however, none of us can entirely discount the potential that something truly traumatic could happen to this very stable entity and render it unstable and ultimately insolvent.  So while an “investment” in US government bonds is generally described as an “investment” the only thing that differentiates it from a “gamble” is the extent to which we can predict the outcome of the USA’s ability to remain solvent.

As I mentioned above, the primary difference between what most people consider gambling and investing is the level to which the outcome can be determined.  For Bill Walters he is not gambling because he has essentially established that the outcome can be determined with a high degree of confidence.  When Bill Walters bought Enron stock, however, he was unknowingly gambling.  Most of the investors who bought bank stocks over the course of the last 25 years were ultimately gambling because the complexity of the banking system created a highly unpredictable environment.  The degree to which most investors can determine the future value of a stock is lower than most of us would likely feel comfortable with.  As I often say, we know less (in most cases MUCH less) than we think we know.   Like Bill Walters, however, some players in the game of investing and gambling simply have better information, knowledge or an understanding of the system that provides them with the ability to better predict the outcome.  For these participants the lines are skewed with regards to what they might consider a “gamble” or an “investment”.  They have an edge that makes the future outcome more predictable.

For the majority of us mere mortals, who are of average intelligence and information, we cannot necessarily determine the probability of an outcome with a higher degree of confidence than the majority other participants in the game.  This is ultimately why most fund managers and small investors lose to a simple correlated index fund after taxes and fees. The key to gambling or investing is increasing the degree to which the outcome can be determined.  This is easier said than done, however, it does not leave the small investor helpless.

In addition to superior knowledge and information players can also increase the determinability of a system by controlling the system to some extent.  Although you can’t establish the rules of a poker game you can manage the game to an extent that you control its outcome to some degree.  Likewise, you can’t control the profitability of a corporation, however, you can control and manage your investment to an extent that you generate a more predictable outcome.  In a poker game this might involve bluffing or managing your cards in a fashion that increases your odds of winning.  A simple example in the investment world is writing covered calls on an equity position.  By writing the calls on an existing position you have created a more predictable outcome.  Of course, in doing so, you have reduced your potential reward, however, the pay-off is a more predictable outcome. Position sizing, money management, hedging, diversification, etc are all forms of managing a system in a way that makes its outcome more predictable.  Like the investor with superior knowledge or information you are essentially creating an edge through the management of the system.  This reduces the degree to which your actions can be described as gambling.

While most “investors” are comforted by the fact that they are purchasing American corporations in a regulated system, the truth is that most of the participants are gambling to a large degree. When you reject the Wall Street sales pitch that you are always “investing” when you buy stocks you can then begin to think about money management and risk management and only then is your entire perception of the system and approach altered.  Your goal as an investor should not be to merely generate profit, but to do so in a manner in which you are managing risk and helping to generate an outcome that is predictable with a high degree of confidence.

On the back of two bubbles, a decade of flat returns and a market collapse, investors are now beginning to reconsider the idea that there is a substantial difference between investing and gambling.   There is, in fact, a gray area between investing and gambling, however, that does not mean you have to be a Wall Street gambler when you purchase equities or other financial instruments.  The degree to which you are a gambler is ultimately determined by your knowledge of the system and your approach in managing that system.  Don’t fall prey to the Wall Street sales pitch that says the purchase of equities is nothing like gambling.  The truth is, we’re all gambling more than we want to admit.  But the difference between the winners and losers is that the winners recognize this fact and exploit it while the losers get taken for a ride.

Source: CBS News


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • FDO15

    Important and great thoughts Cullen. Investors need to admit that what they’re doing is not that different from what the government deems illegal in most states.

    The term “investment” should be saved for people that really build companies and help to generate real economic wealth. The BS that goes on at stock exchanges every day is no different than what you see in a sports book in Las Vegas.

  • InvestorX


    here we come back to the theme of speculation as well. As investing is very similar to gambling, so is any investment decision a speculation (one bigger, one smaller).

    On another point:

    The predictability of returns is maybe not properly defined. The probability of success in gambling can always be exactly calculated (this is what risk is). The problem is that the expected return is negative. The distribution of returns (the odds) in investing cannot be exactly calculated and this is uncertainty, not risk, but the expected return is most of the time positive.

  • cc

    alas, at least in Las Vegas there are laws and rules. In Wall Street they are just banker’s tools and can be modified to their advantage (e.g. mark-to-market…).

  • boatman

    as i stand in line to pay for gas at the store i am routinely behind some girl w/3 babies/kids in clothes full of holes-she’s buying just a pint of milk but 10 lotto tickets.

    i am reminded the lottery is a tax on the mathmatically challenged.

    the state of florida touted this as a way to make more money for the school system to get it passed……then just shell-game-swapped the money for school money(no proof more money makes kids learn anyway)….and they’re still in the red.

    investing is closer to gambling than most of us want to admit.

  • B Ferro

    Look at a log chart of the Dow or SPX dating back 100 years – in addition to death and taxes the other sure thing in life with a 100% predictable outcome, it would seem, is a higher stock market in the future, hardly a gamble.

  • Mercator

    You can bet on a horse. You can bet to win/place/show. Or, you can bet on a stable. In the process, you move from gambling to investing. They’re different and they’re the same. This is not confusing.

  • chris

    “The degree to which you are a gambler is ultimately determined by your knowledge of the system and your approach in managing that system.”

    well put, but i would add one important qualifier.

    it also depends upon your ability to define the system before you try to understand the system and manage it.

    merriwether and his nobel buddies defined the system in a way that reduced it to a model that was incomplete. while one can never define a nonlinear dynamical system with complete specificity, what you focus on and what you ignore (because no person or model can comprehend all of the dynamics) is a selection process that require…..judgment.

  • Lilguy

    Good article on the macro view, but I believe it overlooks the role expertise/intelligence can re-shape the micro gambling-investing spectrum.

    For example, I’m a very poor poker player (but play regularly for small stakes with close friends). My odds of winning long-term would probably be better if I entered the lotto.

    OTOH, and more pertinent, are there not individuals who can consistently do better than others in equity investing (&, of course, some who do consistently worse)? While this may all average out, it suggests there are some who can produce an “alpha” (or a “negative alpha”).

  • Adam

    I watched this piece on Sunday as well, you’ve done a great job summarizing the subtle differences between the two. Some people will just never be able to see how subtle some of these differences really are. Well done sir!

  • Cullen Roche

    Yes, stocks are always a sure thing, right? The Japanese probably wish you’d been there to inform them of that in 1985…..

  • Cullen Roche

    Dont forget the free drinks!

  • ducksoup

    amen to that brother. In Vegas misbehavior will get you crippled, or a disappearing act in the desert. No thievery allowed there.

  • Hammertime

    Even better than Ben Graham’s explanation of “investment”. Thanks.

  • ES

    I agree with everything that is said. It is even mroe of a gambling when it comes to 410K because people participating don’t know the rules of the game, they are playing with a card deck stacked against them and they don’t have a choice not to particiapte.

  • FDO15

    Ferro thinks the market can never fall again. He’s drinking the Fed kool aid.

  • first

    Real Investment is done in private corporation. As soon as they become public it’s mostly irrational. Strong Buys, Up and down grades,technical analysis,momentum buying, research departments recommendation,stock options and dilution.

    The best long term investments in pubic corporations are the one where there are only a few major share holders involve. They do operate more for the benefit of there share holders. Buffet is a good example but there are several others. The incentive of those corporation’s management is to create valuation for there share holders.

    Very large share holder will prevent abusive behavior from executive such as abusive bonus, dilution, generous option plan, rewarding them self for failure by repricing option at substantially lower price.

    If you have a very large stake in a company you tend not to shoot your self in the foot. That to me is where and ho I want to be invested in and is also the part of the market that does not operate as a casino and make us money over time.

  • Max

    The difference between gambling and investing is that with gambling, you know the odds.

  • Johnny

    well, companies can pay dividends, buy back stock, and (often) have huge incentives for long-term stock price appreciation

    there is no such corresponding “backstop” in casino gambling.

    the real con for the average joe is the get-rich-quick approach itself… like recommendations, high-turnover trading, really anything that involves trying to benefit from market structure (instead of the profit growth, innovation, and shareholder rewards of a company).

    my thoughts are simple —
    short-term trading: global macro ideas and risk management
    long-term investing: large bets (as % of portfolio) on high conviction business/industry ideas

  • J

    It is not a difference between anything.

    I watched this clip, with any successful person they know what they are doing so well, it is not 2nd nature to him, it is his complete natural state.

    He is in such full control of his environment without even thinking about what he has to control. This comes with focus and practice, focus & practice of one subject. He did not know how much he had bet, he had to count it up, because he is in full control without thinking about it.

    He lost on wall street becuase it is not his natural state, simple, Jim Chanos did’nt lose on Enron.

    Most people are distracted by many things in life, so they cannot focus & practice on narrow areas; they have kids, jobs, commutes, music, movies, health, and life basically. If you read snowball, Buffett was locked in a room with annual reports every single day & night, if he had a different wife, he may very well not have been Buffett today.

    I was a professional soccer player. I had my best games when I was not thinking, I realized when I over thought pre game, I had a nightmare game. I had the skill, the talent, I didn’t need to think it, I just had to let it happen and when I got to that I played out of my skin, I played at another level completely and I had no idea how I did it and even how I could do some of the things I could do. It was all the games I played all the practice from 5 years old that cumulated into a pinnacle, not 2nd nature, but the natural state of myself.

    This is the power of narrow focus.

  • B Ferro

    Show me another market ex Japan that hasn’t gone up over time and I’d be more likely to agree with your counter point (developed world market)…

  • Cullen Roche

    The great depression comes to mind. 20 years of flat markets. Of course I am not saying that stocks won’t go up over the very long-term. Only an imbecile says that humans won’t evolve and progress with time. The equity markets reflect that. And yes, I am hugely bullish about America in the long-run and I have never forecasted another lost decade. But that doesn’t mean your bets are a sure thing over the time period in which you’re investing…..

  • B Ferro

    I concede that – up to 20 year periods can be lost before one gets back to square one…but yes, over the longerst horizons the line has an upward slant..

  • Cullen Roche

    Yes. I’d be curious to know how many investors really just sit on their positions and hold for 20 years+. My gut tells me that people need the money at some point whether it’s for children’s education, retirement or just splurging….I think the Warren Buffetts of the world are the exception….

  • Kid Dynamite

    don’t you need some discussion of REAL returns here too? and of risk adjusted returns? Ie, of course the line is upward sloping – that’s what happens when the purchasing power of the dollar decreases. And also “of course” – that decreased purchasing power is obviously not the only reason the line is upward sloping – don’t misconstrue me here…

  • Cullen Roche

    Yes. But my brain hurts right now thinking about how stupid the analysts covering AAPL are.

  • goodfriend

    no nonsense post
    that’s what i like at TPC !

  • okl

    lovely post.

  • Ian

    Great piece! Although you touched on it, could your comment specifically on how this relates to the efficacy of the ‘efficient market hypothesis’, and whether the stock market is efficient, random, and/or rational. Thx.

  • Chris

    “A simple example in the investment world is writing covered calls on an equity position. By writing the calls on an existing position you have created a more predictable outcome. Of course, in doing so, you have reduced your potential reward, however, the pay-off is a more predictable outcome.”

    Or as I like to say, “The less you bet the more you lose when you win.”

    It is all a matter of risk.