The funny thing about the stock market is how we feel about it. When everyone is bullish, the stock market is the single greatest source of wealth creation in the world. When everyone is bearish, Wall Street is a casino controlled by old powerful rich white guys who let robots buy and sell stocks while they play golf and smoke cigars.

The comparisons between the stock market and gambling aren’t entirely unfounded. Wall Street can be a casino for some, and a creation of wealth for others. It comes down to the process.

Gambling vs. Investing

Gambling is defined as an event with negative expectations. We know that over time more money goes into a casino than ever leaves. The games are designed to slowly and somewhat randomly take our money from us. Each dollar we put into a slot machine, for example, should turn into $.95. No one believes that they will get rich at the casino. The only people who believe so are addicts.

Investing is different; it’s supposed to have positive expectations. We know that over time more money leaves Wall Street than goes to it. Businesses become more valuable, industries and economies grow, and businesses make money. People who own businesses or lend money to businesses tend to turn their wealth into more wealth. It’s hard to go broke owning a piece of business icons like Coca-Cola or McDonald’s; it’s certainly much harder than going to a casino.

If investing has positive expectations, why do so many investors lose money? If in the long run the stock market has gone up, how can so many people lose? How can the distribution of returns look so much like a casino – very few huge winners with lots of small losers?

I think the stock market can be very much like gambling – and create similar outcomes as a casino – if you do all the wrong things:

1. Failing to diversify – Even the best investors in the world are going to get something wrong. Warren Buffett’s track record was built on successful calls, but he’s had more than a few “unforced errors.” Without question, those who do the worst (but not necessarily those who do the best) in the stock market are those who do not diversify.
2. Not doing due diligence – I don’t go to casinos very often, but when I do I’m astounded that there are people playing at American tables when there are European tables just around the corner. The difference is huge; American tables have two zeros whereas European tables have only one. While everyone there plans to lose, the people who haven’t done their due diligence are losing more and doing it faster. Due diligence is as easy as comparing fees for similar funds before investing, shopping around for the lowest commissions, or actually reading the prospectus for any investment you consider investing in.
3. Moving too much – The gambling industry knows that activity is everything. In a game where the odds are in your favor, the way to make more money is to make gamblers gamble more. Gamblers losses compound with more transactions and the stock market is exactly the same. Active trading and frequent shuffling of accounts creates more errors, more buying high and selling low, and less tax efficiency, all of which bring lower returns. Buy and hold has created far more millionaires than day trading.

These are the three major mistakes that turn positive expectations in the stock market into negative expectations similar to a casino. We know and understand that in the long run the stock market should grow an investors’ wealth just as it has for centuries. Knowing this, we should also know that simply getting into the market and letting it work is one of the best ways to grow our wealth.

Investing in the stock market is like owning a casino. Actively trading, failing to do any due diligence, and concentrating into a handful of unresearched investments is like trying to get rich playing video poker. It just won’t happen.