This is a guest post from Dylan Ross, a Certified Financial Planner and owner of Swan Financial Planning, LLC, a registered investment adviser in New Jersey.
I often hear some variation of the question, “What’s the difference between the stock markets and casinos?” So, I’ll share my typical answer…
While there are several small similarities between casinos and stock markets, there is one large difference. If you go to a casino, buy in, never place a single bet, and then cash out, you receive the same dollar amount you bought in at, regardless of when you cash out.
Now imagine if casinos valued their chips based on how well the casino as a whole is doing. Over the course of a day, the value of those chips might increase or decrease, but let’s say that over time, the increases tended to exceed the decreases. This is more like what has happened with the U.S. stock market.
With the stock market, you can buy into the market as a whole using a broad market index fund, never make a single “bet,” and then cash out at some future point, with the idea that over time the value of your investment can grow along with the market if the market continues to grow.
At the casino, players place bets with the hope of winning (walking away with more than if they never bet at all). In the casino, that would be leaving with any amount greater than what they came in with. People try to do this because they feel lucky, skilled, or believe they have some kind of system.
In the stock market, people trade to try to “win” (walk away with more than if they didn’t trade at all), but in this case a “win” would mean leaving the market with more money than if they simply bought in and didn’t make any trades. People try to do this because they feel lucky, skilled, or believe they have some kind of system. The traders in the market are really not that different from the gamblers in a casino.
In both cases the odds of winning (adding value through betting/trading) are against you, but at least the market lets you participate in its overall growth potential just by being there. Trading, like casino gambling, is a negative-sum-game. For every dollar won over the market, one must be lost; furthermore, whether you’re a winner or loser, you must also pay financial intermediaries.
To summarize, both stock markets and casinos provide the chance to try to do better than others by making bets. Neither have odds that favor a strategy of trying to do better through making bets. Stock markets give you the potential to participate in their growth without making bets. Casinos do not.