At "A Dash" we have tried to draw a clear distinction between investing and gambling. We believe that the analysis of gambling situations frequently provides more data, allowing a long-run analysis. The techniques used are the same that investors should use in evaluating stocks and sectors.
Those buying stocks, whether their time frame is short-term or long-term, frequently focus on the return rather than the risk. This can take two distinct forms:
- Believing in the apparent consistency of returns. This has been costly for investors in mortgage securities, either directly or through hedge funds that leveraged these instruments.
- Swinging for the fences. The investor looks at the potential gain rather than the risk.
The Gambling Lesson
Seeing the risk/reward error is extremely difficult when one already has an investment position. The gambling comparison can help one take a completely different perspective -- one where there is no psychic stake in the outcome.
Accrued Interest provides several lessons on this theme in an excellent post today. The points are difficult to summarize, so we recommend reading the entire article.
Tom Murcko at InvestorGuide.com also provides a thoughtful comparison of investing and gambling, including a good intellectual framework.
Our own comparison is also helpful.
Looking for understanding from different, but analogous situations, is a strong method for improving investment performance.
Many approaches are working well, but investors need to choose with a realistic assessment of risks.