Gallery:Step 1|Step 1: Active Investors

Is Active Investing a Form of Gambling?

Gallery:Step 1|Step 1: Active Investors

Active investors believe they are in control. They delude themselves that they have a special understanding of the market, a superior edge over less knowledgeable investors, making them immune to disaster. The truth is that all investors can access the same information as professional money managers through the Internet and many other sources. Still, many investors believe they are smarter and more sophisticated than the average investor. Those under this illusion fail to realize how much investment performance depends on luck. Most of them eventually pay dearly for this mistake.

Active investing in the stock market is a lot like casino gambling. Take a look at the numerous comparisons in the various news articles below. (Note the references to addiction.)

  • Las Vegas Review-Journal; June 29, 1998, SOS: STUCK ON STOCKS. "By far, the most gambling performed in the world is performed in the stock markets," said Paul Ashe, president of the National Council on Problem Gambling. "More money is lost in the stock market than in legal and illegal casino gambling combined," said Marvin Steinberg, a Connecticut psychologist who specializes in treating compulsive investment gamblers.
  • Northern New Jersey Record: February 2, 1998, High-Risk Investments Online Internet Trading Can Be Addictive and Costly. Dan Gaffney liked the odds. A $1,200 wager, a $150,000 score. He came so close to winning, too. But somehow, he lost. And it didn’t feel like losing $1,200. It felt like $150,000 had just slipped through his fingers.
  • ABC NEWS, February 1, 1999; The Craving to Buy and Sell; Online Trading Becoming Addiction for Some
  • San Francisco Business Times; Options junkies get treatment as chronic gamblers
  • www.800gambler.org January 25, 1999, this article titled "Stock Market Gambling" and Stock Market Gambling and The Addiction Of The Millennium
  • See 20 Questions for Compulsive Gambling? Note Stock market check box at the bottom?
  • The San Francisco Chronicle, August 16, 1999, Losing Your Shirt For Day Traders. For those risk-loving hunters of the stock market, gambling is the essence of their trade

Paul Samuelson

Watching the Grass Grow
Watching the Grass Grow

"My guess is that indexing will have a larger role if you call me ten years from now than it does now. But it will still be a minority mode of investing. Why? There is something in people; you might even call it a little bit of a gambling instinct. They want to be interested in the process of investing, and it's traditionally been difficult to get too jazzed up about indexing. I tell people [investing] should be dull. It shouldn't be exciting. Investing should be more like watching paint dry or watching grass grow," he says. "If you want excitement, take $800 and go to Las Vegas."

- Paul Samuelson, Nobel Laureate, MIT Economist, The Guide to Ultimate Indexing:  To make the most of a growing array of index investments, you need to look beyond the obvious. By Daniel McGinn, September 1999.

The active investor's addiction to beating the odds is often as strong as any other addiction. Like gambling, active investing can be extraordinarily exciting for investors who get carried away by the adrenaline of winning. Of course, it can create significant agony for those who experience the losing side of risk. One of the biggest mistakes made by the active investor is believing there is skill involved when the stock market proves profitable. Many would be day traders have learned this lesson the hard way. In today’s world of computer-driven high-frequency trading, individual traders (or “home-gamers” as Jim Cramer likes to call them simply do not stand a chance). Just like casino gambling, unfortunately, there are more tales about the winners than the losers, but the stories rarely give an accurate accounting of true net profit.

Active investors, like casino gamblers, often do not account for their total return properly. Common mistakes include the exclusion of loads, commissions, taxes, and cash flows in and out of their portfolios. Another common error is quoting the returns of only the portion of their portfolios that performed well. Then there is the problem of hearing only from the winners and not hearing from the losers who seem to disappear into thin air.