I remember my parents having a conversation at the breakfast table when I was eight years old. My mother claimed that stock investing was a form of gambling because you can gain money or lose money and you never know in advance which it is going to be. My father strongly disagreed. He said that investors are buying shares in real companies when they purchase stocks and that the fortunes of the companies are determined by economic realities.
Today I believe that both of them were accurately describing a significant part of the stock investing experience.
Is Stock Investing A Form Of Gambling?
My father was right that stock investing is not solely a gamble. U.S. stocks have been increasing in value by 6.5 percent real per year for as far back as we have good records of stock prices. Stock investing is not a zero sum game, like a poker game is. There are winners in poker. But there are always as many losers as there are winners. When you sit down to play poker with a few friends, it’s not possible that you will all end up with more money in your pocket at the end of the night. Poker players are gamblers.
But my mother was right about stock investing as it works when stocks are overpriced. Today, stocks are priced at two times their real value. People who buy overpriced stocks can do well if they sell at the right time. But for every investor who sells at the right time and ends up a winner, there is an investor who buys at the wrong time and ends up a loser. Stock prices always return to their fair-value level (a CAPE value of 17). So, to the extent that stock prices have traveled to levels above the fair-value price, stock investing is a zero sum game. Stock investing is gambling at times when stocks are overpriced.
Stock investing is not gambling and it is gambling. Most people would say that it is not a good idea to gamble with one’s retirement money. Yet most financial experts encourage people to buy stocks to finance their retirement, even at times when stocks are wildly overpriced. There is a social taboo against describing the true nature of the stock investing experience at times when stocks are wildly overpriced. At such times, most of us ignore the gambling aspect of the experience. We act as if even the irrational exuberance is rooted in some sort of economic reality. In the minds of most investors, stock investing is every bit as legitimate when prices are out of control as it is when prices are reasonable.
I believe that we need to adopt a new perspective on the gambing aspect of the stock experience. I would like to see a social consensus develop that it would be good to keep the gambling aspect of the stock investing experience to a minimum. There are lots of gambling options available to us when we are in the mood for that. Stock investing is something we need to finance our retirements. We should all make an effort to keep the stock market as free of gambling as possible.
I read an article today on the sharp decline in the price of Netflix Inc (NASDAQ:NFLX) stock. As is the custom in articles on changing stock prices, explanations were offered for why the share price has plummeted. The explanations seemed entirely plausible. But the author of the article made no effort to distinguish the portion of the price drop that was caused by a change in economic realities from the portion of the price drop that was caused by investors realizing that a gamble had gone bad. When stocks in general are as wildly overpriced as they are today, it is hard to imagine that Netflix shares were not significantly overpriced. So the company’s stock was more vulnerable to a downturn than it would have been had there been no overvaluation present.
Readers of that article were led to believe that the sharp price drop signifies changes coming for all companies involved in the downloading of entertainment options. And it may be that the development does indeed signify that. But it concerns me that ignoring the effect of overvaluation causes everyone who watched these developments to misinterpret them. Much of the price drop was due to the general overvaluation of the stock market and signifies nothing about the downloading of entertainment options. It can hardly be a good thing for us all to be misled re these matters. We would be better off if prices were reasonable and if price changes signaled what they appeared to signal.
We shouldn’t be taking gambles with our retirement money. We should all want the stock market to be operated on the level. A stock market being operated on the level is a stock market in which prices reflect economic developments and nothing more, a stock market in which irrational exuberance is kept to a minimum through the intelligent use of market timing.
Rob’s bio is here.