Gambling

Dave Smith of the amazing Soft Skills Engineering podcast posted something that caught my eye:

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I took the rare step of responding:

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…and again:

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Looking back at it now I don’t much care for my own tone, and so Dave - I’m sorry about that.

I do stand by the major points I made though, if not all the details. I could just use a little more space to clarify them, so here we are.

The benchmark matters

As I posted, I had in mind the inherent skewness of stock returns. The median stock actually performs significantly worse than the market overall. This is counter-intuitive, but it’s because a very small number of extreme winners (which prove to be incredibly difficult to predict ahead of time) pull up the average. Only about one third of stocks meet or exceed market dollar-weighted average returns - that’s the pool that stock pickers are picking from. This translates to the performance of retail DIY stock pickers, who typically earn returns closer to that of the median stock (like throwing darts at the choices) before fees are factored in.

But I did mess up one thing in my thinking: this doesn’t translate to net wealth loss, only market under-performance. The money primarily being “lost” here is only in the form of opportunity cost, compared to what could have been earned with index funds. So while a bookie will take home a spread, and a casino will set house rules that give it at least a 51% chance in any game, the same isn’t quite true of stock picking. You still have a solid chance of earning money, just most likely less than you could have earned by simply holding an index fund (and with higher fees).

Sound investing is not gambling

I’m taking liberty with definitions again, but I don’t consider most real world stock picking behavior to really be “investing”. Investing should be following a long-term plan with clear instructions about what to do at various times. This was one place I did manage to keep my head even on twitter: I reserved my criticism for “Picking stocks”.

I actually personally have my investments 100% allocated to stocks. Interesting research by Scott Cederburg et al shows that for a definition of risk (again playing definition games…) more like “risk of not meeting your long-term financial goals”, this is the least risky asset allocation because of the durable risk-adjusted expected returns of the stock market. I use ETFs that are very close to index funds - the details of the difference don’t really matter here, I may write more about them another time.

Gambling: a human behavior

This is important. While a technical definition of gambling might focus on the nature of purely placing a bet on a real-world occurrence, the mental condition of a gambling addiction can express itself in all kinds of real-world markets as well. For the gambler, a stock buy order is a monetary “bet” on the future value of that specific stock. From a human standpoint, it’s the same core behavior.

When I saw that tweet, my mind immediately went to people engaging in stock market speculation¹ and the potential effect of this kind of statement on them. The idea that “it’s not technically gambling” is maybe just not what we ought to be putting out there, when there’s actually a vice here that’s behaviorally indistinguishable from gambling.

~tjp