By now you are likely sick of all the chatter about tonight’s astounding $1.5 billion Powerball lottery drawing. I have been quite critical of lotteries in the past. They are a classic grab for the free lunch, a desire for the benefits of wealth without the sweat and hard labor.
This is no small issue: As a nation, our lottery habit is truly stupendous:
Americans spent more than $70 billion on state-run lotteries. To put that into context, that’s more money than Americans spent on sports tickets, books, video games, movie tickets and music plus all of the apps, games and programs bought from Apple’s iTunes App Store — combined.
That’s a ridiculous amount of money.
I have long believed that what you get for your $2 Powerball ticket is the opportunity to fantasize what you would do with your newly acquired hundreds of millions of dollars. (Disclosure: I bought $20 of tickets for tonight’s drawing). As my Bloomberg View colleague Matt Levine explained:
For me, being two bucks poorer would not impact my quality of life at all, while being $1.4 billion richer (with probability .000 [lotta 0s]1, and yes I know there are taxes and a lump-sum haircut) would impact my quality of life really quite a whole lot.
For most people, that’s exactly right. The two bucks won’t hurt you, while the upside is a game changer.
However, you are not most people. If you are reading this, you most likely are not looking for a way out of poverty or despair. Lottery tickets, scratch-offs and other such unlikely long shots are primarily the province of the poorest citizens. This probably is who Mark Twain (or maybe Samuel Johnson) had in mind when he observed that gambling is a tax on stupidity.
The pushback to idea that gambling is a tax on the feeble-minded is the notion that investing is little different from buying lottery tickets. It’s a big capitalist casino, with sky-high odds that put almost everyone at a disadvantage.
So here’s the question: Is investing like gambling?
The short answer is, it shouldn’t be. The longer answer is more nuanced, although the simple truth is that for some — perhaps most — people, investing is almost indistinguishable from gambling. (Spoiler alert: It depends upon how you do it.)
When a person is gambling, they are relying on an event’s random outcome over which they have little or no control. Whether it’s slots or craps or roulette or Powerball, games of chance are just that. Other games such as poker or black jack require some skill, although luck remains a key aspect of the outcome. The unifying issue across all of these is that the odds are stacked against the gambler, with the house invariably the winner.
If that description reminds you of your own portfolio, than you have an investment-process problem.
Your goal as an investor should be to eliminate as much of the element of chance from your process and, like the house, stack the odds in your favor. This is true whether you are actively pursuing alpha (market-beating returns) or passively accepting beta that matches the market.
How do you become the house? You:
- understand the nature of risk
- are comfortable with the idea of uncertainty
- rely on long-term measures of valuation
- use mean reversion as a guideline to unknown future outcomes
- allow time to work in your favor
- understand the impact of leverage
- recognize the folly of relying on forecasts
- consider all possible outcomes, including extremely rare black-swan events;
- accept that some losses are inevitable
In short, you do everything you can to ensure that your methodology is sound. You must recognize that while you can control the investing process, you have no control over any single investing outcome.
That’s the full difference between investing done right and gambling.
Investing done wrong doesn’t meet most or all of the above qualifications. It becomes speculation, which is just a polite term for gambling.
In light of the Powerball drawing this evening, the question presented to each of us is simply this: Are you an investor or a gambler?
Originally published as Powerball Isn’t Investing and Vice Versa