Dear Fellow Investor,
Most people would say buying shares of a company or buying a bond is investing. Similarly, there’s probably pretty good agreement that placing money on a number at the roulette table or betting on your home team in the big game is gambling.
But what about options trading? Crypto? And now along comes predictive markets.
It’s a fuzzy line separating gambling, investing, speculating, and simply preserving capital. And it’s not always easy to tell. There’s some consideration about being smart versus being lucky. But luck plays a role in investing too. As Supreme Court Justice Potter Stewart famously said in a 1964 pornography case, he couldn’t define it exactly, but “I know it when I see it.” That’s equally true in talking about a range of money-making activities. A fuzzy line.
That fuzzy line has gotten even fuzzier in recent years as fantasy sports, sports betting, crypto, and prediction markets have all gone mainstream. As a result, sometimes I hear people talking as if they’ve made an investment in something when in fact they’re gambling and they’ve made a wager.
My list of the activities most readily available to the general public where they can use money to make money includes:
- Bank Accounts
- Money Markets
- Index Funds
- Bonds
- Gold
- Stocks
- Real Estate
- Prediction Markets
- Commodities
- Crypto
- Options
- Short Selling
- Sports Betting
- Day Trading
- Casino Gambling
And here’s my take at placing these activities on the 4-quadrant graph shown above. I will freely admit there is room to quibble on the precise placement, but that’s not the point. The following chart provides a rough layout of how these activities depend on luck and skill:
More important than the role of luck and skill is the interplay between risk and reward. With the same caveat as above – the precise placement of each isn’t critically important – this chart shows the activities in which your likely reward is disproportionate to your risk, and the activities where your risk is excessive.
A few notes about this chart (with links to some of my previous posts where applicable):
- Day Trading: As I discussed in a recent post, day trading is an activity in which almost everyone (97-99%) underperforms the market.
- Casino Gambling & Sports Betting: In both of these activities, there is a market maker – the casino or bookmaker – which takes a cut. By design, they always win on average. That means the participants always lose on average.
- Short Selling: As I wrote in my column last year, there are a number of reasons that most people should avoid short selling, not least because of its susceptibility to manipulation.
- Crypto: Despite comparisons to gold as a way to store assets, crypto is untethered from any real-world, tangible source of value. More importantly, it does not act as a hedge on stock market investments; it amplifies them. And because it has no tangible value, the volatility of crypto is even greater. For a long-term investor, however, this volatility will likely not be an issue, and $10,000 of Bitcoin could show a very nice return 25 years from now.
- Prediction Markets: These are markets in which you can bet on almost anything – election outcomes, stock performance, number of hurricanes in a season, if and when a CEO will get fired, etc. While this data can be helpful to get a real sense of how people feel about certain things – they are literally putting their money where their mouth is – it is subject to manipulation in many ways right now, including insider information, greatly increasing the risk to the average participant. Beware.
The main point of the chart above is that there are certain activities that have a better risk:reward ratio for the average person, behaving within the limits of the law. These are the activities below the yellow line above and include stocks, options, index funds, real estate and money markets (depending on the interest rate environment).
Another aspect to consider in thinking about these activities is their sensitivity to time. In many instances, the risk drops over time, or the likely return increases. Variances that can be substantial on any given day tend to smooth out over time. As mentioned above, crypto is a prime example and may be the most time-sensitive of this list.
I’ve put all of this together in one table below. I have classified Skill, Luck, Risk, and Return as either low, moderate or high. This refers to the typical or most likely outcome. There are, of course, exceptions.
| Skill | Luck | Risk | Return | Time Sensitive | |
| Bank Accounts | Low | Low | Low | Low | No |
| Money Markets | Low | Low | Low | Low-Mod | No |
| Index Funds | Low | Low | Low-Mod | Moderate | Yes |
| Bonds | Low | Low | Low-Mod | Low-Mod | Yes |
| Gold | Low-Mod | Moderate | Low | Low-Mod | Yes |
| Stocks | Moderate | Moderate | Moderate | Moderate | Yes |
| Real Estate | Mod-High | Moderate | Mod-High | Moderate | Yes |
| Prediction Markets | High | High | Mod-High | Mod-High | No |
| Commodities | Moderate | Moderate | Moderate | Moderate | Yes |
| Crypto | Mod-High | Moderate | High | High | Yes |
| Options | High | Moderate | Moderate | High | Yes |
| Short Selling | High | High | High | High | Yes |
| Sports Betting | Moderate | Moderate | High | Moderate | No |
| Day Trading | Moderate | High | High | Low | No |
| Casino Gambling | Moderate | High | High | Moderate | No |
These activities appeal to overlapping segments of the population. Earlier in my life, being located in the Boston area, many of my friends were fund managers at Fidelity. In addition to being really smart, they were highly competitive as a general rule. Many of them also gambled at casinos, bet on sports, and traded options. Participants in prediction markets also are more likely to day trade, buy crypto, and bet on sports.
I do not find casino gambling to be fun, but I understand why many people do, and what they choose to do with their free time is none of my business.
Investing, on the other hand, is my business here at Cabot. Literally. And we do have opinions on what makes for good investing. Stocks. Options. Real estate (REITs). ETFs. Bonds. Money markets and bank accounts. Even gold has its place. Other than that, most investors are taking on unnecessary risk of loss or reduced gains.
Since you are reading this, I can assume you’re some level of serious investor. That is something that our team of investing strategists and analysts is here to help you with.
Regardless of whether you’re an aggressive or conservative investor, the level of investing activity you prefer, or your growth or income goals, we have experts and advisory services here to help you. For the disproportionately risky activities I’ve talked about, have fun. We can’t help you with that.
___________
How do you draw the lines between gambling, speculation, capital preservation, and investing? Which do you participate in? Share your thoughts with me. Email support@cabotwealth.com.
For your investing success,
Ed Coburn
President, Cabot Wealth Network
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