Many times when try to dissuade someone from “investing” in FX, Crypto, etc., and steer them towards stocks, I get back “Well aren’t stocks a form of gambling too?” Let’s take a look at that.
The financial definition of “Investment” from Wiktionary is as follows:
(finance) A placement of capital in expectation of deriving income or profit from its use or appreciation
The definition of “Gambling” is as follows:
An activity characterized by a balance between winning and losing that is governed by skill and/or chance, usually with money wagered on the outcome.
There is an important difference between these two very different definitions: The “expectation of deriving income or profit” part. It isn’t simply what you “expect”, as in “I expect Toyota stock will go up 10% tomorrow!”
The word “expectation” as in “expected profit” or “Expected value” has a specific and mathematical meaning in finance. Basically, it’s a weighted average of all of the scenarios.
For example, if you have a 50% chance of earning a 10% profit and a 50% chance of earning nothing, then your “expected” profit is 5%.
Stocks are ownership
Sometimes people forget this, but stock certificates represent ownership in a company. Each share of stock is only a small fraction of the company, but if you owned all of the stock, you would own the company outright. Stocks are simply a way to share ownership of a company among many people.
Let’s start with a tame example, Tokyo Waterworks (Formally: “Tokyo Metropolitan Government Bureau of Waterworks”, also known as TW).
TW has a business model that is well understood and has been around a long time. They pump fresh water out of ponds, lakes, or rivers, filter it, disinfect it, and pump it to businesses and residential customers.
The water itself is free, but cleaning it requires equipment, chemicals, other supplies, and manpower. Water mains must be constructed so that water can be delivered to customers, and those pipes need maintenance.
So although the water itself is free, there are expenses. The company charges enough fees so that the costs are covered, and a small profit remains. Actually the amount of profit is quite large, but when viewed as a percentage of revenue, it is on the order of 3-4% annually.
Most of this profit is distributed back to the stock holders as dividends, so if you bought a stock of TW for 10,000 JPY, you would see a dividend of somewhere around 300-400 yen each year.
The amount goes up and down year by year depending on investment, expenses, etc. – but the long term average is relatively stable. They are the only game in town, and everyone needs water.
So, if you invest your money in TW, you can expect to earn a relatively stable profit for decades to come. They aren’t going to suddenly have a blockbuster year due to an explosion of demand for new innovative products, nor is demand for water going to go away. Likewise, the cost of the water they pump from lakes isn’t going to change much.
Salaries and equipment prices may go up, and it may take them a while to compensate with rate hikes, but overall the situation is relatively stable.
Since the dividends are stable, so is the stock price.
Clearly, investing in TW is not like “betting it all” on black or red at the roulette wheel. You are not likely to find yourself bankrupt tomorrow.
Still, you can imagine scenarios where having all of your eggs in the TW basket would leave you in trouble:
- There is a financial scandal like Enron. This is very unlikely, but always possible.
- There is a giant earthquake that destroys lots of infrastructure. This is always a possibility.
- Some other unforseable event or trend.
In order to improve your already good chances, you could also invest in other utilities like Tokyo Gas, Tokyo Electric, and Internet companies. These also all have a long history and well understood business models. Since most electricity in Japan in generated from natural gas, and most gas is imported, gas and electricity prices can change rapidly – but people will always need electricity, and probably gas too.
Still, a large earthquake or other natural disaster could cause infrastructure to all of these companies since they are all located in Tokyo.
To mitigate that, you could also invest in utilities in Okinawa, Kyushu, Osaka, and Hokkaido.
You could even invest in utility companies overseas, like Philadelphia Electric Company, etc. – but then of course you start to run exchange rate risk. Since many things you buy are probably imported if you live in Japan, this actually could be a good thing.
Why am I talking about utilities? Because they have captive customer bases, regulated rates, long history, and well understood business models. This means they are usually very stable, as companies go.
Hopefully you can see that investing in a portfolio of utility companies across Japan and other countries would be relatively “safe”, while also providing more income than something like government bonds.
Looking at the polar opposite type of companies, the likes of Amazon, Apple, Google, etc. are much more likely to surge in price when a new product turns out to be more popular than expected, or drip in price when a new product flops, expenses rise, etc. These types of companies also don’t typically pay dividends either, and since nobody has a crystal ball, it’s hard to know the “correct” price for these stocks.
Betting on any single one of these companies is indeed gambling. Imagine you invested in Apple or Google 25 years ago. Now imagine you invested in Blackberry or MySpace.
One thing is still true, though, though it would take a crystal ball or time machine to know which of these companies would succeed – the winners always make more than the losers lose, so if you had a wide portfolio of such companies, you would always make money in the long term.
Consumer product companies like Kao in Japan and Proctor & Gamble or Unilever overseas are much more stable than technology companies since everyone needs soap and toilet paper – but they usually pay somewhere between what tech companies and utilities pay.
Drug companies tend to do well even in a recession, when restaurants and bars struggle. After all, everyone still needs their medicine.
So, if you invest in a big basket of all of these things, then you can, over the long term earn a pretty penny. When the tech companies, movie studios, and the like hit it big, or there is a blockbuster drug, you will earn big as well. When there is a recession or some companies die out, you will also need to ride out low, or potentially negative returns – but if history is any guide, the market will return to growth.
If you aren’t betting on any specific company when you buy a stock index like the eMaxis All Country fund, then what are you betting on? Well, basically, the progress of humankind.
Despite all of the bad news we hear every day, the scandals, the wars, the human rights abuses, etc. – the trust is that poverty has been decreasing almost every year. More people than ever have running water, electricity, washing machines, etc. These people will live better lives, and have more time to contribute to society instead of barely surviving. They will start companies that need investors to grow beyond a certain point, and you can be a part of that.
That said, it’s important to remember that buying stock is investing into a business. Buying a stock index is just investing into lots of businesses at once. It doesn’t make any sense to buy a stock and sell it tomorrow than it does to invest in your friend’s dry-cleaning business or restaurant and then ask to pull out your funds the next day.
Most businesses survive because they are doing something useful to society. They are producing vegetables and fruits, new drugs, microprocessors, tasty bread, useful chemicals, winter coats, bicycles and microwaves, or the latest movie or killer app. They stay in business because people pay for their goods and services, and they in turn provide jobs for their employees. This is why it makes sense to invest in a company.
Compare this to day trading. You buy a share of Toyota today at 8,000 yen, not because you have done some analysis of their dividends, assets, and liabilities to determine that 8,000 yen is a fair price – but because you “expect” someone else will go up to 8,500 tomorrow. That’s not helping anyone or contributing anything to society in any way – and it is very much gambling, since there is also a decent chance it could drop to 7,500 tomorrow instead.
Betting on FX or Cryptocurrency is even worse.
A friend of mine recently asked me “Oh yeah? Then why does FX exist?” FX has legitimate uses. For example, if you have a contract in a foreign currency that is due several months in the future, you might want to convert the money now so that you aren’t at risk of the rates changing. (Or, you might want to buy options so that you minimize your risk due to currency fluctuations without actually converting the money now).
These things are important and necessary for international business, and there may even be instances where they are useful for personal use (Are you saving up for a house overseas?) – but betting that the price of the Dollar or Euro will go up or down is pure speculation. Gambling in the truest sense.
What about Cryptocurrency?
Well, talking about the well established “currencies” like Bitcoin and Etherium, I can simply say this – there is no reason why they should go up except for inflation of the yen- and if that’s your concern, precious metals are a much better option.
The original goal of Bitcoin was to be an international money system free from interference from banks and governments. Free from sanctions and censorship. Perhaps a noble goal, but along the way things have changed.
The main uses of Bitcoin and similar “coins” has been for criminal activities, money laundering, and speculation. Bitcoin itself is completely worthless. It can’t be melted down to make jewelry like Gold, and it can’t be used to pay taxes or other debts like government currencies. Almost no stores most people shop at will accept it, and so you need to convert it back into Yen or another actual currency to buy much of anything.
And… not only to transactions take a long time to clear, the value fluctuates wildly, making it a poor currency.
If it’s not a currency, it must be an investment, right? Well not so fast, it’s not like a business. It doesn’t provide valuable goods and services to society, so it can’t be “expected” to earn a return. In fact, the only ones who can “expect” (in the financial sense) to earn a return from Bitcoin are the exchanges – just like stock exchanges earn nice commissions from day traders.
What’s more, other cryptocurrencies like “memecoins” are almost all just scams. I can only shake my head when I hear people act surprised at losing money on these schemes. Of course they did!
Someone I knew told me about a complex scheme they “invested” in, where they would get paid 1% per month, “risk free”. 1% per month is 12% per year. I mean, just use a little bit of critical thinking. If anyone could earn 12% per year, risk free, everyone would be doing it. What magic does this cryptocurrency company do that they earn more than Toyota, all while taking on no risk? What’s more, why would they pay 12% to you to borrow your money when they could just borrow money from the bank at something closer to 2-4%?
At best, cryptocurrency is akin to electronic beanie babies or trading cards. When people are interested in it, they will bid up the price, when they lose interest, the price will fall. That sure sounds like gambling to me.
So, is stock investing akin to gambling? Well, it can be. If you invest all of your money into one risky company, then you are very much gambling with your future. If you invest your money long term into an index that includes thousands of countries in dozens of industries many countries around the world then you are investing in the future of humankind – and helping to ensure prosperity for everyone.
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