Are You Gambling Or Investing?
Learn How To Profit More Consistently By Using An Investment Strategy With A House Advantage
Key Ideas
- Mathematical expectancy is the key to consistently profitable investing.
- Shocking truth! Most of what passes for investment advice is really gambling.
- How to stop gambling so you can invest for greater, more consistent profits.
Do you know if you're gambling or investing?
Both are games of chance. Both involve probabilities where you put money at risk with the hope of a return, and both can make your hard earned savings vanish if you bet wrong.
So what's the difference between gambling and investing, and why should you care?
The difference boils down to one simple concept that sounds intimidating, but is actually easy to understand: mathematical expectation.
The reason you should care about mathematical expectation is because it tells you how much profit (or loss) you can expect if you follow a gambling or investment strategy long enough to establish statistical significance.
“God does not care about our mathematical difficulties. He integrates empirically.”– Albert Einstein
So what?, you might say. Have a look at the proof.
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Here's How You Could Have Profited From This Investment Advice…
- Did you know the mathematical expectation for a diversified stock portfolio at the end of the 1990's was actually negative for 10 year holding periods, depending on assumptions? This isn't hindsight. These facts were known at the time, and you could have used this knowledge to manage your risk and reduce the losses that many investors experienced during the following years.
- Did you know the mathematical expectancy for 20 year holding periods of stocks at the end of the 1990's was so low that bonds were highly likely to provide a better risk adjusted return than stocks … for 20 years? I'll bet nobody told you that one! Yet, look at what happened to bonds in the following years.
- Did you know the mathematical expectation for your diversified portfolio of stocks, ETF's, or mutual funds varies with the valuation of the market at the time you acquire the portfolio?
- In other words, if you bought equities when P/E's were higher than average, and book value ratios were lower than average, you could expect lower than average returns. Conversely, you can expect higher than average returns if you begin your investment program when stocks offer a better value than normal.
What's Investment Advice Like This Worth To You Over Your Lifetime?
If you answered “millions,” you're probably being conservative. Understanding mathematical expectation is literally the difference between wealth and poverty because it's the ultimate determinant of your profits over the long term.
Mathematical expectation governs your ability to compound wealth.
You can't choose out of this rule because it's inviolable.
“A technique succeeds in mathematical physics, not by a clever trick, or a happy accident, but because it expresses some aspect of physical truth.”– O.G. Sutton
The markets and your portfolio will compound and grow according to mathematical expectation whether you know it or not. This isn't my opinion – it's mathematical fact.
You have only one choice, and that is to choose whether you make the principles of expectancy work for you or against you.
How Does Expectancy Work With Investment Strategy?
It's common knowledge that the odds of an individual coin flip are 50/50, or even odds. If you bet one dollar on heads and received one dollar as a reward every time the coin came up heads, you'd break even or very close to even after flipping the coin enough times.
The mathematical expectation under such a betting scheme is break even.
In other words, mathematical expectation is a function of two variables:
- The probability that your bet will be a winner or loser
- The payoff of a winning bet contrasted with the amount lost for losing bets
“In mathematics you don't understand things. You just get used to them.”– Johann von Neumann
Stated more simply, expectancy equals probability multiplied by payoff.
For example, if you varied the payoff to $2 for every winning flip, and $1 lost for each losing flip, you'd suddenly have a positive expectation game assuming your odds remained unchanged.
This is an important concept.
Ask yourself if you know with any confidence what the expectancy is for the investments in your portfolio.
Do you know the probabilities and their payoffs? My guess is that fewer than 1 in 100 investors have the foggiest clue about the expectancy of their investment strategy.
Amazing when you consider it's the mathematical rule that determines their profits over time.
Investors should only risk money on positive mathematical expectancy situations; whereas gamblers risk money on negative mathematical expectations and unknown probabilities. That's the crucial difference between a gambler and an investor.
In fact, an investor really isn't a gambler at all because his profits are assured over time – it's just a question of sample size.
Are you investing, or just gambling? Do you even know?
The objective of investing is to profit, and the only way you'll profit over time is either by sheer luck, or by betting on positive mathematical expectancy situations.
If you don't want your financial future in the hands of “lady luck,” then you have no choice but to learn about expectancy.
How To Know If You're Gambling Or Investing
I invest for one reason … to make money. Period.
For that reason, I refuse to put a single dollar at risk unless I know the odds are hugely in my favor, and I can make the same bet enough times to realize a profit.
Very few investment strategies qualify under that criterion:
- Buying stock because you think it will go up doesn't qualify because it has no known mathematical expectation.
- Buying stock because you think it's a good company or has good prospects for the future has no expectation.
- Buying stock because you think the market will go up, or because you think it has hit a bottom is also gambling because it has no expectation.
- Buying stock because your advisor or some other expert recommended it is gambling because it has no expectation.
“You can not apply mathematics as long as words still becloud reality.”– Hermann Weyl
The sad reality is most people invest based on opinions that have no mathematical expectation … and that is gambling.
All the above reasons for buying stock are nothing more than opinions, and opinions are nothing more than conjectures about an unknowable future.
They might as well be playing blackjack or roulette because they're betting on an unknown or negative mathematical expectation.
What is the expectancy of my opinions?
If I make 10 or even 100 investments based on opinions, what results can I reasonably expect? I haven't the foggiest clue! No idea. No expectation. I'd simply be guessing, and I'm not willing to guess when it comes to my financial future.
Pay close attention and you'll be shocked that most of what passes for investment advice from experts in the media, publications, and even your own financial advisor, is little more than meaningless opinion … mere conjecture.
They're gamblers and not investors.
If You Want Consistently Profitable Investment Results, Then Take This Advice …
To get even more clear about the crucial difference and to understand whether or not you're gambling or investing, let's examine the difference between the casino owner and the casino customer.
The customer gambles, but the casino owner runs a business. The owner knows he will profit consistently based on the law of averages because every game played puts the odds on his side.
The customers have good days and bad days, but lose over the long term because they're betting on negative expectancy games.
“The gambling known as business looks with austere disfavor upon the business known as gambling.”– Ambrose Bierce
Similarly, your investment strategy either positions you as the owner or the customer. You either run your portfolio like a business with a house advantage, or you gamble. There's no other alternative.
Another clue that you're a gambler is if you get a thrill from your investment activities. Investing is sexy and exciting to a gambler just like the casino customer who enjoys the thrill of the game and the roll of the dice.
True investing is about as dull as watching paint dry because it's just business. It's an administrative task requiring disciplined implementation of a pre-set strategy that's devoid of emotional excitement.
The casino owner comes to work every day, checks his numbers, solves problems, and does his job. He's merely implementing his plan with discipline, thus profiting with certainty.
Which better describes your investment activities – the casino customer, or the casino owner? Are you investing with a known house advantage in a business-like manner, or are you rolling the dice in hopes of the big score?
Investment Strategy “Nevada Style”
The analogy between gambling and investing falls apart in one crucially important place. This critical distinction is the basis by which you can develop a consistently profitable investment strategy.
In gambling, the rules of each game are pre-defined to give the house an advantage – a positive mathematical expectancy.
Conversely, that means every gambler has a negative expectancy.
With investing, there's no pre-defined “house advantage” because there's no “house”.
The odds of the investment game are determined by how smart you play the game. You can become your own “house”. You make the rules.
In other words, unlike gambling where the casinos are in control of the odds because they make the rules, in the world of investing, you're in control. You determine the odds by the risks you choose to accept.
Investing is like gambling in a casino that lets you decide whether or not to bet after you have seen the cards. This advantage is hugely important to understand! It cannot be understated.
As an investor, you determine the odds by carefully selecting which hands you choose to play and which hands to avoid.
In other words, investors determine the probability, risk, and reward. They only risk their capital when the expectancy is highly favorable.
You control the risk and reward of your portfolio by creating investment rules that give you the equivalent of a house advantage.
You can be a consistent winner if you develop the knowledge and skills necessary to only invest in high expectancy situations.
Consistently profitable investing is literally that simple.
Investment Advice: Never Bet Without A House Advantage
What's almost unbelievable to me is that most investors absolutely blow this advantage.
They hold the key that can unlock the door to reliable and secure investment profits, but they walk right past that door and choose the casino instead.
Anyone can develop the knowledge necessary to stack the odds in their favor and invest with a house advantage, but almost nobody does. Most investors are really gamblers.
“Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it.”– Will Rogers
Most people choose to entertain themselves with stock picking and hot stock stories rather than focus on making money. They don't know the odds and don't want to be bothered with things like math. They prefer to risk money guessing at the next Google or Microsoft rather than investing with skill and discipline.
The choice is yours. You can learn how to take charge of mathematical expectancy and invest with a house advantage, or you can gamble and leave your financial security to chance.
Which will you choose?
Want to Learn More about Investment? Pick Up a Copy of My Book.
If you invest, then it’s a near certainty you’ll encounter investment fraud. Nobody is immune.
Other than holding a diversified portfolio, there isn’t any proven way to know when to buy or sell stocks. Hindsight is a great teacher, but not predictive. “Only invest in high expectancy situations” means you are taking a gamble as well. There’s a strong chance you will be wrong. The great investment minds out there tell you there is no way to tell when and what the market will go up or down.
Boomerst3 I can always rely on you to aggressively assert the conventional wisdom of low cost, passive index, buy and hold as the only solution. However, it is important we keep our facts straight here and not confuse opinion with fact.
First off, expectancy investing principles has no beef with buy and hold because it does in fact have a provable positive expectancy given a sufficient holding period. However, what is less commonly understood is that it delivers a miserable risk/reward ratio from periods of high overvaluation/low interest rates such as we have today. In other words, my assertion is that it’s not that it’s invalid: it’s just not efficient or optimal or desirable.
You further state ” there isn’t any proven way to know when to buy or sell stocks” when that is patently false. There is an extensive amount of both academic, and academic quality, research showing quite the opposite. None of the methods are perfect as there is no perfect solution, but they are statistically valid.
You then state that investing in high expectancy situations is taking a gamble as well when quite the opposite is true according to my definitions. You state there is a “strong chance you will be wrong” when it is important to distinguish we are not discussing probabilities but instead expectancy. It is probability times payoff. Overall, your whole discussion here is confused and not factually accurate.
You then go on to assert how the great market minds will tell you there is no way to know if the market will go up or down, and finally we have something we agree on. There is absolutely nothing in expectancy investing principles about forecasting markets because the future cannot be forecasted with enough accuracy to put capital at risk. We fully agree here.
Finally, you say diversification is the key. This is a half truth. Diversification is important and valid and should definitely be implemented; however, the two real keys to investing are expectancy and risk management.
Finally, you state to leave the crystal ball at home. As stated earlier, there is nothing in expectancy investing about forecasting or crystal balls. You are adding that to the conversation, but it has no relevance.
Bottom line, is expectancy investing does not attack buy and hold. It is valid and meets the expectancy investing required principles.
However, it is false to claim buy and hold is the only solution or even the most effective solution.
Getting a little defensive here, aren’t you Todd. You say one can profit more consistently doing what you say. How many times do we hear that from folks trying to sell their wares? How many sidebars do you have saying ‘buy my book”, implying that will help one profit more consistently? I disagree with your view on probabilities versus expectancy. Sounds like you treading a very fine line here. Apparently you don’t take kindly to anyone questioning your assertions.
Todd…your comment here:
You further state ” there isn’t any proven way to know when to buy or sell stocks” when that is patently false. There is an extensive amount of both academic, and academic quality, research showing quite the opposite. None of the methods are perfect as there is no perfect solution, but they are statistically valid.
If this were true, why wouldn’t all the brilliant minds out there simply do it, and all their clients would be filthy rich? You know the answer to that.
Boomerst3 I have no problem with people respectfully questioning my assertions; however, I do request that opinions be clearly labeled as opinions so that other readers can separate opinion from fact.
I replied to your comment line by line because it stated opinion as fact, misstated facts, all the while contradicting the article so I felt it was important to clarify what was what so other readers could benefit from the discussion.
You can view that as “getting a little defensive”, or you can view it as respecting your comment (and the thousands of buy and hold readers who share the thinking your comment illustrates) by taking the time necessary to carefully craft a reply that addresses each issue.
Additionally, this comment and the follow-up below it are getting a pretty aggressive and accusatory tone so I think it is relevant that you question whether this is the right community for you. I’ve never claimed that my message is right for everyone. Maybe you should just consider unsubscribing if you’re not happy with the ideas shared here.
For example, your implication on selling books implies I have some hidden agenda when the reality is I’ve never made any secret that this is 100% a business. I sell educational products and services including books, coaching, and soon courses of instruction. I 100% have an overt, fully disclosed, business agenda, and I’m totally okay with that.
In fact, this article directly references an upcoming course and book I will be selling that fully explains Expectancy Investing. You can either see it as a grand conspiracy to get people’s money, or you can see that I’m providing education on a subject for free and I will have paid resources later (nothing for sale now) for people that want to learn more. However, none of this is hidden or mischievous. It is 100% out front for all to see.
Finally, you state that the distinction between probability and expectancy is treading a fine line. This is patently false and illustrates a lack of understanding of the issues involved. I encourage you to study the distinctions because they are very important. Collapsing them into one will cause inaccurate thinking.
Hope that helps clarify.
Boomerst3 Actually, I don’t know the answer to that. Maybe you can share your OPINION.
I have lots of thoughts and beliefs, but no clear answer.
I’ve been practicing these principles since the early 1980’s and research has continued to grow supporting the investment strategies I advocate. They’ve always worked and continue to work, yet they’ve never been adopted by the masses.
Instead, the masses are are more consistent with the position you advocate which bring up a favorite Mark Twain quote, “Whenever you find yourself on the side of the majority, it is time to pause and reflect.”
Hopefully this article and the comment thread has given you something to pause and reflect about.
It will be helpful to know what your mathematical expectation for https://www.financialmentor.com/investment-advice/10-commandments-of-investment-strategy/13136 currently shows and how you arrived at it. In that way, it will serve as a record too. Thank You.
pelawren Current expected returns for US stocks over a 10-15 year time horizon are low single digits compound annual growth. In other words, the overvaluation we face as of this publication date on 07/29/15 places us in the top decile of overvaluation with expected returns significantly below average.
What is particularly disturbing about today for traditional “buy and hold a diversified portfolio advocates (see Boomerst3 comment below) is that bonds offer no refuge this time around with no positive expectancy net of inflation. (see my earlier post https://www.financialmentor.com/investment-advice/investment-strategy-alternative/bond-bubble/9064 discussing the bond bubble for further elaboration.)
In most of market history, either bonds or stocks provided sufficient positive expectancy to carry the day for a diversified portfolio. This time around both are inflated to extremes.
Financialmentor pelawren Thank You
Great article, like many before. In your first bullet points about the late 90s, you assert that expected returns were negative for stocks and were better for bonds and, significantly, that this was NOT based upon hindsight. I understand the concept of expected returns over long periods, but how does one determine current, real-time information on expected returns that can positively affect investment decisions today? Is there a source for current expected returns for future 5-, 10-, 20-year periods, etc?
Neal3 There is an extensive body of research showing the strong statistical relationship between valuation at the beginning of your holding period and subsequent 10-15 year holding period returns for a diversified portfolio of stocks. A good starting point would be Irrational Exuberance by Shiller, but there is much more beyond that. A simple Google search on related terms will provide many, many resources relevant to the valuation aspect of expectancy investing. Current valuation statistics are equally available from any basic Google search. Hope that helps.
Hi Todd,
This article is one of the most eye opener article I ever read in the entire financial literature!!! Wow, I am speachless…
Thanks, really great content!
Yan Fortin 🙂
Montreal, Canada
happyanski Thanks for sharing Yan! I appreciate you taking the time to join this discussion. If you have a minute to comment on the points that really stood out for you that would be a great addition. If not, I at least appreciate your supportive comments. Thanks!
Mr. Tresidder,
As someone who has no real experience in investing but is committed to learning more, I can say that I really value your posts. They are informative, insightful, and are very well written. Thank you for doing all of this work. I’m glad I found your site.
N0N_Affiliated Thanks! I really encourage you to learn as much as you can, but always pay attention to the difference between fact and opinion. Only accept into your mind those facts that can be supported by the data and independently verified. There is a lot of opinion and unsupportable belief around investing that gets passed off as fact (see the discussion below with Boomerst3 as an example). Just because something is repeated by 100s of resources doesn’t make it true, and just because something is inconsistent with conventional wisdom doesn’t make it false. The other thing to be careful of in your journey to learn more is contextual half-truths. There are a lot of contextual half-truths with investing where you need to understand where the rules apply and where they don’t.
I’m probably making this sound more complicated than it is. It’s all actually very simple once you understand it, but it is difficult to assemble the knowledge from all the contradictory resources.
Financialmentor N0N_Affiliated Excellent advice, sir. I tend to seek the counsel of others who are more skilled than I am, so I already have half of this problem in the bag. And yes, I know plenty of people who use the buy-and-hold strategy, and I see how low cost index funds are helpful to a person’s portfolio. But I’m a person who loves to understand the big picture and spends time learning how things work, so I can make an informed decision. Which is why I’ve avoided the market up to this point. Very complex. There are too many people who put their self-interests before others. And don’t get me started on the big name corporate financial advisors and their cookie cutter solutions. Anyone with a brain can do that. But with Financial Mentor, I can say that you’ve already won a convert. By providing some very useful information and writing in a concise way, you’ve simplified a complex subject. Since I work in digital content marketing, I have a finely tuned bullshit detector. So far you are passing the test. You seem to be the real deal, and I will certainly spread the word about your valuable advice and all of the great products you have. I really look forward to more of your insights. Thanks again for all of the great work you put into this.
Thank you, Todd, for the great insight and guidance.
You’re welcome, Dell. Glad it was helpful.
Hi Todd,
Thank you for the articles. I find them intriguing and thought provoking. I’m new to taking a more active role in my investments and therefore lack, what may be to others, basic knowledge. Please forgive me if my questions are a bit on the beginning side of the spectrum. I have begun some outside reading on the subject, as you suggest. I don’t need or expect to be told exactly what to do, as your articles create a different kind of expectancy for your paid product, which is only reasonable and smart. Still, some questions, with the understanding that everyone’s situation is different.
If stocks are overvalued and bonds are overvalued, what is left? Another category of investment, such as real estate? Or simply get out of the bond market and stock market? Or, as I suspect, to invest in a narrower subset or subsets of stocks that indicate a more positive mathematical expectancy? Thank you for your insight.
hightops56 Unfortunately, the math says this will likely prove to be a very difficult time for traditional investment strategy over the next 10-15 year holding period based on expectancy analysis. It doesn’t mean there won’t be great years between now and then. It just means the long-term, passive hold approach looks unfavorable for both asset classes.
Your base reasoning for how to handle this is right on track. You are really left with two fundamentally different choices.
1: Alternative assets – this could be real estate as you alluded to (depending on local valuation) or it could be properly valued foreign equities and bonds. The idea is to find assets that have not become overvalued as a result of U.S. government policy.
2: Alternative strategies – you could apply different strategies that actively manage risk to provide an acceptable risk/reward ratio.
In short, there’s really only two choices – alternative assets, or alternative strategies.
Again, this is long-term analysis based on 10-15 year expectancy. It says nothing about what could happen for months or even a year or two along the way.
Hope that points you in the right direction!
Financialmentor hightops56 Thank you for the reply. One more question and then I’ll bow out and let you get on with your life.
I get that you’re talking about an overall 10-15 year window, not the variation within, and I understand your response regarding alternative assets (real estate–I’m in the San Francisco area, where we like our real estate hilarious and ridiculous) but I don’t quite understand what you mean by alternative strategies. Do you mean buying and selling more frequently, when it makes sense? Your system seems to depend on expectancy, which depends on the 10-15 year window but your alternative strategies seem to suggest more active movement within that time frame. Perhaps the two are not necessarily exclusive or I am just not understanding.
Thanks again!
hightops56 Financialmentor There are a variety of alternative strategies that are valid. That is what I’ll be teaching in the course. All involve some activity, but not a lot.
Sorry to hear about your market being San Francisco. I visit there occasionally and yes, the prices are beyond insane.