It's common for some people to think that investing is much like gambling. You risk your money in hope of getting rich. It's very easy to confuse the two since we're getting distracted every day by loud television personalities or hearing predictions about what is going to happen and how we can get rich by following their instructions. Most of the time this kind of investing doesn't work so we look for the new investment/gamble to try, only to find that doesn't work either.
This is so close to true, but there is a huge error. Investing and gambling are not in the same league, ballpark, or sport. But speculation - speculation is just like gambling.
Speculation is when people place their money into different securities hoping they will be paid off in the short run. Even in the industry they call it making a bet. You can bet against the market, bet on one company, or bet on a new currency. But it's no coincidence that bet is the same word we use in gambling. I've heard of people who want to speculate in penny stocks, specific industries or sectors, specific companies, and even markets. You may have heard of people who want to get in on water stocks because they watched a movie, people who were told they need to get in on solar, people who are excited about marijuana companies, or people who like a certain company's products. Giving our money to these very specific investments hoping to get rich doing it is speculating.
In the world of investing, generally speaking there are two kinds of risk. There is risk that most of us know about. This is compensated risk. There are phrases we've all heard like, "no risk, no reward" that are rooted in this kind of risk. This is the kind of risk we want to take. The other risk is uncompensated risk. The markets do not reward you for taking these kinds of risks. This includes investing in single companies, single currencies, single industries, single countries, and so on. The markets don't reward this kind of risk because it's very easy to diversify these risks away. Another way to define speculation is taking on uncompensated risk and hoping we get lucky.
Investing is giving our money to whole market segments. When we invest, we put our faith in capitalism. Do you think competition will continue to make products better and cheaper? Do you think profits will incentivize innovation? When you invest, you invest in all companies across the world. By diversifying out of all uncompensated risk, you are left with just compensated risk. You lend your money to companies that make the products and services that we use every day.
Now, just because we are rewarded for taking compensated risk doesn't mean it's easy to do. Investing is a long term play. Do you think that stocks will do better than bonds in the long run, just as they always have? Do you think that bonds will do better than cash in the long run, just as they always have? I do too! By focusing on the long run and putting together a portfolio that has just the right amount of compensated risk that we have the ability, willingness, and need to take, then we can focus on living our lives instead of paying attention to the financial circus on TV.