Gambling and Investing

Suppose you pay $1 to roll a pair of dice and you win $30 if you roll a 12.

Do it once and you may be lucky and make $29 profit.

Do it 10 times and you could make $290 profit, though the probability of that is about 1 in 4 thousand trillion.

But, if you do it 10 times, you might well win once and make $20 profit. Though you are more likely to not win at all and just lose your money.

If you played 100 times, you would most likely win 3 times and thus make a $10 loss. Though it’s still quite possible that you would make a profit (or a bigger loss).

Do it 10 000 times and you would most likely win about 278 times and so make a $1660 loss. It is extremely unlikely that you would make a profit or that you would lose more than $3000.

In the long run, for every dollar you bet, you will lose 16.6c. In the short run, what you win or lose might well be quite different from that. But in the long run (like 10 000 games) you can guarantee to lose very close to 16.6c per game or $1660 in total.

This game is set up so that players on average get back 83.4c for each dollar they play and lose 16.6c. If a casino offered that game, it is possible that they would lose money on the first couple of times people tried it (though unlikely). However, in the long run, they would be guaranteed to make a profit – a profit paid for by those who played the game – the gamblers.

Poker machines are set up to give about the same return – to pay back about 85c for every dollar put into them. Play a few times and you could win (though you more likely won’t). Play thousands of times and you are virtually certain to lose. Other casino games like roulette, blackjack etc, have slightly better odds, but all are stacked in the favour of the casino, so, in the long run it is impossible to win. Casinos rely on that fact for their lucrative profits.

So playing the pokies or gambling at the casino might be fun, but it is guaranteed to lose you money in the long run. Despite this, many people who are struggling financially gamble in the hope of making money. They might do so once or twice, but in the long run they’re just donating their money to the casino.

It would be nice if casinos offered a game where they paid out $1.10 for every $1 played instead of just 85c. They don’t because everyone would play the game and the casino would go broke. But there is a place where, if you play $1, you are more likely to end up with $1.10 than 90c. And in fact, in the long run, you are virtually guaranteed to make money. It’s called the stock market.

A casino is a zero-sum-gain set up. Meaning that for people to make a profit, other people have to lose the same amount. The stock market is not a zero-sum-gain set up. It can happen that everyone’s shares increase in value. And in general they do, especially over a sufficiently long time period.

The graph below shows how $100 invested in the US share market in 1980 would have grown to $6900 by 2025. $100 invested in the pokies in 1980 would have shrunk to $0 before the end of 1980.

Of course, shares don’t rise in value continuously – they can fall, like in 2008, but falls are always temporary; after a fall, they always rise back up to where they were and further.

Poker machines offer the promise of instant wins. Wins do take longer on the stock market, though, with an investment of say $100 000, it is quite possible to make a few thousand dollars in a single day. It won’t happen every day, but it will happen more often than it does on the pokies and you don’t lose heaps in between wins.

Investing in shares is easy as long as one has a few thousand dollars or even the capacity to borrow a few thousand dollars at a reasonable interest rate. The graph above shows an average annual increase of about 10%, and on top of that, many shares pay a few percent per annum in dividends, giving an effective return of around 12% p.a. It is generally possible to borrow money at a much lower interest rate than 12% p.a.

Of course in Australia, all working people have a superannuation account. If an employer pays you $50 000 a year, they have to put a further $6000 a year (12% of your wage) into your super fund. Even at that relatively low rate of pay, after 5 years you would have at least $30 000 there.

The money in your super fund is invested, so it grows each year from investment earnings as well.

You have the choice of how your super is invested. The default is usually a mixture of cash, bonds, shares, real estate and other investments. Cash and bonds tend to pay little in the way of investment earnings – maybe 3% p.a. – hardly enough to cover inflation – but they tend not to ever go down in value. Shares can fall in value sometimes (like in the GFC of 2008), but on average they earn a lot more than cash and bonds – like 12% p.a. including dividends.

As mentioned, super funds tend to invest your money in a mixture of cash, bonds, shares etc., and as such they might make on average about 8% p.a. They do this because your balance tends to go up and down less – you don’t make as much, but you don’t lose as much when things go bad either.

This can be important if you are going to need the money in two or three years’ time. But if you are young, your money is going to be in there until you are at least 60, so you are better off having it all invested in high-growth options like shares. Let’s say you have $30 000 in your super account at age 25. At 8% p.a. average growth, by age 60 that $30 000 will have grown to $444 000. At 12% p.a., it will have grown to $1 584 000. Of course you will end up with more than that, because employers will put a lot more money in over your working life.

Super funds sometimes recommend higher-growth investment when you are young, and safer, lower-growth investment as you approach retirement. There seems to be an implicit assumption here that you will spend all your super the day you retire. In fact, most of it will quite possibly stay invested for another 20 or 30 years. So transitioning to low-growth options like cash and bonds is not necessary – and generally not advisable. Most people will die with money still in their super account.

And for those who enjoy the thrill of a bit of a gamble, super funds allow their customers to change their investment mix as often as they wish. If the economy is going well, you can have it all in shares; it it’s looking bad and share prices look like falling, you can change it all to cash which will not suffer a fall however bad things get for other investments.

People well into their working lives can easily have more than a million in super and a good day on the stock market can see their balance rise by tens of thousands of dollars in a day. The only way that would happen on the pokies is if you’re prepared to lose tens of thousands of dollars most other days.