Gambling, Speculation, and Investing

I want to clarify the terms in above title with more precise definitions than we normally run across. These terms are all used interchangeably, for example, something we hear a lot of recently "investing is gambling", because the stock market has been pretty treacherous. But investing is not gambling, as I hope to make clear. We also hear these terms used interchangeably too often by folks who should know better (and probably do), an example of which might be "this new company has a great new idea, and it's a great investment".

Why am I bothering? The distinction can be important for anyone hoping to put savings to best use, so I think it's a useful exercise.

Gambling: betting on capital gains into a low probability environment. What that means in simple terms is the odds are stacked against us being correct in our assessment of which side of a bet to take, and we are as (or more) likely to suffer a capital loss than achieve a gain. By extension, there is no such thing as an intelligent gambler, as an intelligent person would try to avoid bets where probabilities are obviously against them, as in a casino for example, where you cannot bet "with the house", only against it. Obviously, an intelligent person will try to avoid taking any bet when probabilities cannot be discerned to be in their favor.

But, it's not a completely black and white situation, since in most cases assessing probabilities for future turns of events (predicting the future) involves judgement. The problem is wishful thinking (otherwise known as delusional thinking) can (and will) creep into the judgement process. It's frequently pretty easy to detect when probabilities are against us (casino), but usually not so easy to detect when they are with us. However, there are cases where a positive probability is more detectable, and that leads us to the next term.

Speculation: a bet in the direction of a positive probability. A positive probability is a subjective assessment, so one never knows exactly what that probability is. Is it a 60% chance of being correct, or is it 75%? We can't know that, so we strive to find those situations where we think a probability is very likely in our favor. If we are successful in our judgements, capital gains on our bets are also likely.

Of course it's easier in retrospect to identify high probability ideas that come along, the personal computer may be the best example of this, but it is not impossible to recognize in real time a good idea likely to succeed. Successful speculators are then, by definition, perceptive, well informed, and disciplined enough to hold fire until the higher probability idea becomes apparent.

Our final category is a different kettle of fish entirely than either of the preceding. But these categories can blend also, which gives rise to the imprecise definition problem to begin with.

Investing: buying a piece of something (a company or a property, for example) that is profitable, whereby we receive a share of that profit according to our ownership percentage. The price one pays is important, because if we pay too much the resale value of the investment can fall, canceling profit derived from ongoing operations. Buying an investment property at a good price has a name, Value Investing. It is actually a blend of investing (in an income steam) with speculation (on capital appreciation). In general however, with investing the emphasis is on income. Also in general, unless one finds a better use for capital, there is no particular reason to sell an investment that continues to generate reliable income.