Are we through the looking glass?

[Shawn]

Quote:

Originally Posted by Grep All this talk about the stock market being mere "gambling" is ridiculous. Yes, there is risk, and that risk can feel like a gamble. But stock ownership is the ownership of companies that have real value and produce real products (except A.I.G., of course). Invest in a Total Stock market fund, and you own a slice of the productivity of the United States (or the world). That may sputter at times, but it is a far cry from plunking money down at a roulette wheel.

But in the short term, the stock market is a gamble. Or better said, it's high risk (i.e., it's why short-term funds should be placed in conservative investments). On a day-to-day basis, there is little difference between the equity market and a single roll of a roulette wheel. The odds of success in both cases is about 50%. With the equity market, daily success is a little higher than 50%. With the roulette wheel, daily (one roll) success is a little lower than 50%.

This is not to say that identical forces drive investments and gambling. Gambling is driven by simple mathematics. The stock market is driven by a complex set of time dependent variables. Some are close to random. Others are systemic. And no one knows the full equation. But in terms of outcome, on a short-term basis, I can't tell the difference between a prudent equity investment and the roulette wheel. It's only in the long-term that the difference becomes clear.

All this is nothing more than saying that equity-based investment strategies need to be long-term. Although there's still risk, the likelihood of long-term success is high. It's also a way of saying that gambling is a long-term investment strategy for casinos, as long as they keep their expense ratios low.

[snodog]

Quote:

Originally Posted by Shawn The odds of success in both cases is about 50%. With the equity market, daily success is a little higher than 50%. With the roulette wheel, daily (one roll) success is a little lower than 50%.

But it is those few percentage points that make all the difference. Show me that roulette wheel with a success a little higher than 50% and I'll start playing that too.

[Shawn]

Quote:

Originally Posted by snodog But it is those few percentage points that make all the difference. Show me that roulette wheel with a success a little higher than 50% and I'll start playing that too.

Absolutely. In terms of outcome, this is the difference between equity investing and gambling. The two are on different sides of the 50% boundary. Although short-term risks are roughly the same, long-term risks are not. Ultimately, investing wins because it is based on economic return and growth. Over the long-term, return and growth are almost guaranteed to be greater than short-term volatility and economic fluctuation. It's reversion to an upward-trending mean.

[Koolau]

Quote:

Originally Posted by snodog But it is those few percentage points that make all the difference. Show me that roulette wheel with a success a little higher than 50% and I'll start playing that too.

Actually, snodog, you simply need to buy the casino. Then the odds are suddenly in your favor. That's the theory of purchasing equities. You now own pieces of companies who, to some extent, get to control the odds. Of course, there are good casino managers and bad. So just 'cause the odds are in our favor doesn't insure that we always win.

[NW-Bound]

One of my brothers in law has said that investing is gambling. I have tried in vain to use exactly Shawn's argument, that he should look at investing as being the house, that the odds are for you in the long run. But it does not mean you should put it "all on red". Yes, doing so may mean he could win really big, but he could also lose it all. Diversify, diversify, I told him...

He simply did not get some simple concepts of probability, so I have stopped talking about investing with him. There is no point.

About staying in the market through bad times hoping to recover, some times ago I read an article on the Web. I forgot the exact point of the article, but the author used a phrase that stuck with me. He described the "triumph of the optimists", how they have won more often than lose. Is it really different this time? I have chosen an AA that I am comfortable with, and am willing to sit this out.