Kuta Beach

Kuta Beach

Tuesday, 2 November 2010

No Difference Between Gambling and Investing

Today is the day of the Melbourne Cup, which means over 100,000 people will flock to Flemington to engage in betting on the outcomes of numerous horse races.

Due to personal reasons I will not engage in any betting during the Melbourne Cup as I believe horse racing is animal cruelty. In my opinion, racing a horse is similar to raping a horse. But that is not the main topic of this blog post.

I remember a long time ago I had a friendly argument with a friend over betting versus investing. I put to him the idea that betting and investing are the same thing. He disagreed and believed that betting is a losers game whereas investing is a winners game.

Most agree that conventional investing involves taking ownership of some company or some asset that will appreciate in value in the future thereby making you a profit.

But if you believe an asset will rise in value, is owning the asset the only way to take advantage of this? Why not bet? What is the difference? Usually betting does not involve taking ownership of the asset that will appreciate. For example, suppose I believe that UK house prices will go up in a month's time. My friend believes that if you think UK house prices will go up in a month's time then the way to win from this is to buy a house in the UK. Very simple. This is the conventional way of investing.

However, why not bet? Using IG Index's house price spread betting platform, you can wager that house prices will rise and make money from it. In fact, there are many arguments in favour of betting rather than investing in this case. By betting, you don't actually own the house and therefore you don't have to pay numerous taxes including stamp duty and land taxes. You avoid all sorts of other costs associated with buying houses such as real estate agent fees, lawyers fees, bank fees, and so forth. However, it is not costless to bet on house price increases. IG Index makes money through bid-ask spreads. But nevertheless, what's the difference? Both methods (investing and betting) involve costs. Both methods involve risk. Both methods involve you assessing the situation, taking a position, and making a bet.

There is no difference between gambling and investing.

But my friend believes otherwise. He says that gambling institutions never lose because if it were likely that house prices will rise then they will change the bid-ask spread so that they take a substantial amount of your winnings. But how is this any different to investing? If it were likely that UK house prices would go up, that would already be factored into prices. The high demand for houses would push up prices thereby increasing the costs of buying houses. This effectively increases the costs of betting that house prices will rise. Because house prices are higher, they are more likely to fall. Try this thought experiment. Imagine you have 100 people. Imagine every single one of those people believed house prices will go up. This means they all buy houses and house prices rise. Can house prices go up further? No, it cannot because there are no more buyers. Everyone who had faith in house prices rises has already purchases houses and there are no more buyers left in the market. There can only be selling, and selling reduces prices. Since there are no more buyers, prices cannot go up anymore.

Image: Waffler

No comments: