Investing v gambling: Is there a difference?

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November 05 2019
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Investing money into the stock market and trying to pick a winner at today’s Melbourne Cup aren’t as different as you might expect, according to a mathematician.

In conversation with nestegg, University of Melbourne’s Professor Peter Taylor said “unstructured gambling”, which incorporates complicated games, such as sports betting and horse racing, have similar mathematical outcomes to investing in the sharemarket.

Similarities

Diversification

Like any fund manager will tell you, putting all of your eggs in one basket is a recipe for disaster.

Much like shareholders who invest their money into multiple different shares in a variety of sectors, bookies do the same thing.

Professor Taylor outlined how “if they have a lot of people betting on one horse, they might lower the odds on the horse or take the money themselves and bet with another bookie on the horse, just so they get some money back if the horse happens to win”.

Past performance

Much like picking shares, choosing a horse is not a precise decision based on mathematics – various factors can change the outcome.

Investors in shares are relying on previous performance to predict the future of a share price, while punters rely on the same knowledge with horses.

In both situation, institutions and bookies, as well as retail investors and punters are both trying to gain an edge at potentially the other’s expense.

“All the random things that happen with 24 horses, jockeys, different conditions, different parts of the track and random events, if you put them all together, nobody can possibly have a model that comes up with anything remotely of an assessment of real possibilities,” Professor Taylor said.

He added that in order to choose a horse, punters predict a result based on past performances, including a horse form in set conditions, much like choosing a stock.

Both are gambling

The professor said that due to a concept in mathematics known as random events, both sharemarkets and horse racing are really a form of gambling.

“People might not think of it that way. The math has a concept called a random event. Nobody knows what is going to happen. We might have an assessment of what is going to happen, but nobody knows what is going to happen,” he outlined.

“Nobody knows what the price of a particular stock tomorrow, much like the Melbourne Cup – even though we might have an assessment of probabilities.”

Differences

Zero sum game

While both gambling on unstructured games and investing money into the stock market have similarities, only one has a zero-sum game.

A zero-sum game is a mathematical representation that shows participants either gain or lose in equal balances.

In gambling, the outcome is black and white, with participants either winning or losing.

However, movement in shares is gradual and investors could see themselves going slightly up or down.

“If you buy some shares, it might go up a bit, therefore you’ve won a bit. Or it might go down a bit, therefore you’ve lost a bit, but you still have some value.”

“What you are really betting there is the margin. If you buy a ticket on a horse in a Melbourne Cup, it could be ‘each way’, which might have some intermittent outcomes as well,” the academic said.

Time factor

Another key difference between the two activities has to do with time. Gambling is a time-bound event, while investing in a company can last theoretically much longer.

With gambling, once the race or game has begun, the opportunity for an investor to make a gain or loss is gone.

With stocks, investors can be rewarded for spending time in the market through dividends – meaning that over the longer term, an investor can get in front.

Access to data

While both horse racing and investing rely on past information in order to gain information that might predict future performance, only shares have information available at all times.

“The bookies have a subjective assessment, and the punters have subjective assessments,” Professor Taylor said.

On the other hand, investors are able to look up the code for any company and see relevant financial data.

He gave the examples of a casino or a bookmaker not needing to inform punters of previous cards dealt or the reasoning behind their odds for a particular horse.

The subjective access to data allows both the punter and the bookie to make an educated guess based on their knowledge, while investors in sharemarkets are all theoretically presented with the same information.

It allows educated punters to possibly gain an advantage, according to the scholar.

“Your assessment of probabilities if you’re a bookie is probably pretty good, but it might be the case that a punter knows better,” the professor concluded.

About the author

Cameron is a journalist for Momentum Media's nestegg and Smart Property Investment. He enjoys giving Aussies practical financial tips and tricks to help grow their wealth and achieve financial independence. As a self-confessed finance nerd, Cameron enjoys chatting with industry experts and commentators to leverage their insights to grow your portfolio.

About the author

Cameron is a journalist for Momentum Media's nestegg and Smart Property Investment. He enjoys giving Aussies practical financial tips and tricks to help grow their wealth and achieve financial independence. As a self-confessed finance nerd, Cameron enjoys chatting with industry experts and commentators to leverage their insights to grow your portfolio.

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