Investing is often difficult to discern from gambling, in fact many day trading strategies are based on the same principles of successful gambling. By successful gambling, I am referring to those gambling strategies that leverage the statistical odds built into the wager system to strategically pull out a profit and not the casual betting you and I may do at the school auction.
I was recently at an angel investing conference here in Seattle. The conference was put on by the great TechStars Azure team and was focused on explaining the angel investing process. There were a variety of angel investors speaking from professionals like Geoff Entress, Chris Devore, and Andy Sack to angels who also have a day job like T.A. McCann and Christina Storm.
During the talk, one comment struck me as particularly interesting because it was so casually mentioned but so important and hard to understand.
There is “lottery ticket” angel investing and the is “adding value” investing , and there is a wide gulf between them – from #AngelDay
— John Sechrest (@sechrest) March 26, 2013
John obviously felt that this was an interesting statement as well. John of course is the instigator behind the Seattle Angel Conference. My thoughts on participating in the Seattle Angel Conference from the investors perspective will have to wait for another post though as I want to explain a little more about why investing in lotteries is a tricky topic for the average investor to sort out.
Pictures speak a thousand words, so here is a picture that represents the perspective of buying an investment vs. buying a lottery ticket. This is from the investors perspective of course…
Obviously lottery tickets or any gambling for that matter have the potential to return profits to the investor, similarly gambling and investing both have the potential to lose. On this short time frame, it is difficult to discern between the two. Over a longer time horizon though, it begins to become obvious which of the two activities is gambling and which of the two activities is investing.
This principle is true in real estate investing, public market investing, and angel investing alike. At the point in time that an investment is being made, there is always a lot of unknowns to the investor which makes it difficult to determine if the purchase will be more of a gamble or more of an investment. Combine this with the near term return potential being the same and the investor has a much more difficult time telling the two apart.
Dealing with those unknowns is where good investors set themselves apart from mediocre investors and all investors set themselves apart from gamblers. Taking action to remove the unknowns and mitigate the risks that the unknowns create is what investors do… some better than others. This can be through deep understanding of the market, team, etc. or it can be through deep connection to an advisor who is doing the same. Mitigating the risks can be through hedging investments, portfolio management, or active engagement in the investment.
The gambler on the other hand takes due diligence lightly if at all and does nothing to mitigate the risks that the potential investment presents itself. Keep in mind the gambler and the investor may be purchasing equity in the same firm – there is certainly nothing preventing gamblers from buying into great opportunities. The difference is that the gambler is there by chance and the investor is there by intention.
Investing takes focus and discipline… and a longer time horizon.