Gambling vs Investing

Gambling vs Investing

Is investing gambling? Not really, but some may think they are investing when in fact the odds are firmly stacked against them.

While both gambling and investing involve risk, the nature of that risk is fundamentally different:

• Gambling is based on short-term luck, where the odds are stacked against you. “The house always wins” is a statement of fact in the long run.
• Investing, on the other hand, is about efficiently capturing the long-term growth on offer in equity and bond markets.

Let's talk statistics: It takes decades of active manager performance to statistically distinguish luck from skill, longer than the tenure of most managers.

The illustration below helps to explain why (see footnotes):

Statistically distinguishing between active manager luck and skill using excess return, tracking error and a 95% confidence interval.

Despite the above, many investors focus on short-term (3-5 year) performance to build their portfolio, perhaps relying on the “best-buy” list provided by their platform. This is much more akin to gambling than investing!

Instead, accept that true skill is extremely hard to come by (at least after costs!), and remember that if you thought of it, chances are so did the market.

Focus on long term asset allocation, diversification and have faith that capital markets are a robust mechanism for delivering long term growth.

Many statistical methods exist to derive skill from luck. The number of years required is increased with greater tracking error and decreases with greater excess return.

For some context, of 1,083 US large cap equity managers around 10-years ago, just 2 delivered an information ratio of >0.4 compared to the S&P 500 to the end of September 2024.

🖇️Morningstar Direct, Albion Strategic Consulting - GAME™