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Barry Ritholtz: Powerball isn’t like investing, and vice versa

Chino Hills 7-Eleven store clerk M. Faroqui celebrates with customers after learning the store sold one of three winning Powerball ticket on Wednesday, Jan. 13, 2016.
Chino Hills 7-Eleven store clerk M. Faroqui celebrates with customers after learning the store sold one of three winning Powerball ticket on Wednesday, Jan. 13, 2016. The (San Bernardino) Sun via Associated Press

By now you are likely sick of all the chatter about the astounding $1.5 billion Powerball lottery drawing. I have been quite critical of lotteries in the past. They are a classic grab for the free lunch, a desire for the benefits of wealth without the sweat and hard labor.

This is no small issue: As a nation, our lottery habit is truly stupendous. In October, I wrote: “Last year, Americans spent more than $70 billion on state-run lotteries. To put that into context, that’s more money than Americans spent on sports tickets, books, video games, movie tickets and music plus all of the apps, games and programs bought from Apple’s iTunes App Store – combined.”

That’s a ridiculous amount of money.

I have long believed that what you get for your $2 Powerball ticket is the opportunity to fantasize what you would do with your newly acquired hundreds of millions of dollars. I bought $20 worth for Wednesday night’s drawing. For me, like for most people, the two bucks doesn’t hurt, while the upside is a game-changer.

If you are reading this, you most likely are not looking for a way out of poverty or despair. Lottery tickets, scratch-offs and other such unlikely long shots are primarily the province of the poorest citizens. This probably is who Mark Twain (or maybe Samuel Johnson) had in mind when he observed that gambling is a tax on stupidity.

The pushback to the idea that gambling is a tax on the feeble-minded is the notion that investing is little different from buying lottery tickets. It’s a big capitalist casino, with sky-high odds that put almost everyone at a disadvantage.

So here’s the question: Is investing like gambling?

The short answer is, it shouldn’t be. The longer answer is more nuanced, although the simple truth is that for some – perhaps most – people, investing is almost indistinguishable from gambling. (Spoiler alert: It depends upon how you do it.)

People who gamble are relying on an event’s random outcome over which they have little or no control. Whether slots or craps or roulette or Powerball, games of chance are just that. Other games such as poker or black jack require some skill, although luck remains a key aspect of the outcome. The unifying issue across all of these is that the odds are stacked against the gambler, with the house invariably the winner.

If that description reminds you of your own portfolio, than you have an investment-process problem.

‘Become the house’

Your goal as an investor should be to eliminate as much of the element of chance from your process and, like the house, stack the odds in your favor. This is true whether you are actively pursuing alpha (market-beating returns) or passively accepting beta that matches the market.

How do you become the house? You:

▪ understand the nature of risk;

▪ are comfortable with the idea of uncertainty;

▪ rely on long-term measures of valuation;

▪ use mean reversion as a guideline to unknown future outcomes;

▪ allow time to work in your favor;

▪ understand the impact of leverage;

▪ recognize the folly of relying on forecasts;

▪ consider all possible outcomes, including extremely rare black-swan events;

▪ accept that some losses are inevitable.

In short, you do everything you can to ensure that your methodology is sound. You must recognize that while you can control the investing process, you have no control over any single investing outcome.

That’s the full difference between investing done right and gambling.

Investing done wrong doesn’t meet most or all of the above qualifications. It becomes speculation, which is just a polite term for gambling.

In light of the Powerball drawing, the question presented to each of us is simply this: Are you an investor or a gambler?

Barry Ritholtz, a Bloomberg View columnist, is the founder of Ritholtz Wealth Management. He is a consultant at and former chief executive officer for FusionIQ, a quantitative research firm. britholtz3@bloomberg.net, www.ritholtz.com/blog

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