Is investing in stocks gambling?

Question: I have heard horror stories about people initially earning from the stock market and then eventually losing more than what they had invested. Is investing in the stock market a form of gambling?–Newbie Investor

Answer: Well Newbie Investor, why don’t we first define what gambling is. According to dictionary.com, to gamble means to play at any game of chance for money or other stakes. The same source said a game of chance was one in which the outcome was determined by chance rather than by the skill of its players. Chance is defined by our source as the absence of any cause of events that can be predicted, understood or controlled.

What are not games of chance? Courting a girl, working to get ahead in one’s career and starting a business are just some examples. While there is no guarantee that a young boy can win the heart of the apple of his eye, that an employee can get a promotion and that a small business will grow and flourish, the skills and well thought of action plans of the boy, employee and businessperson will at least minimize the downside risk. Their endeavors are not simply left to chance.

The same is true with the stock market. Investing in the stock market becomes gambling only if you plunk your money into stocks and believe the price will go up because… This is similar to the attitude before when people would rush to buy stocks of a company conducting an initial public offering because of the belief that the stock’s price would jump on listing date.

Investing in the stock market now is supported by in-depth fundamental research and real-time technical analysis. Ordinary analysts and fund managers have evolved into Certified Financial Analysts. Sales agents and financial advisers have also enriched their credentials by acquiring additional certifications such as the Registered Financial Planners and Certified Financial Consultants. Both the Securities and Exchange Commission and the Philippine Stock Exchange have undertaken moves to protect the investing public while constantly demanding professionalism from industry practitioners. Most importantly, the experience of the old guard of fund managers and stock brokers is relied on heavily in this increasingly volatile investing world. When industry practitioners invest or get people to invest in stocks, they surely do not leave matters to chance.

But look at how volatile the stock market was (as measured by the Philippine Stock Exchange composite index or PSEI) in the last five years as shown in the following chart. Since you, Newbie Investor, do not possess the skills of market practitioners, would investing in stocks make it gambling for you?

The answer is simple. You should just do peso cost averaging (PCA) and buy the components of the PSEi if you want to invest by yourself. You may also leverage on the expertise of industry practitioners by buying into pooled funds also via PCA, which is periodically buying into investments using fixed peso amount. When the investment’s price goes up and becomes expensive, you buy less of it with your fixed peso amount. When the investment’s price goes down and becomes cheap, you buy more of it.

Look at the table below and see how implementing an annual PCA strategy produced stellar returns over the past five years. Please note, however, that past performance does NOT guarantee future returns.

Years Compounded Annual Returns as of end 2010
PCA on PSEi PCA on Mutual Funds Excess Return of PCA on Mutual Funds over PCA on PSEi

1 year 37.6% 45.2% 7.6%
3 years 50.7% 53.8% 3.1%
5 years 24.9% 29.7% 4.8%
Source: Philippine Stock Exchange, Philippine Investment Funds Association.

Using the data from the table, a person investing say P100,000 yearly through PCA on the PSEi would have grown his money by P37,600 if he started one year ago from 2010, by P177,000 if he started three years ago from 2010 and by over P319,000 if he started five years ago from 2010.

Doing a PCA on the PSEi is passive investing that does not leave things to chance. This is because components of the PSEi are the most actively traded on the stock market. A stock’s market value is a reflection of an arm’s-length exchange transaction on a specific date between a willing buyer and a willing seller, where both parties acted with full knowledge of what they were getting into or out of. The presumption is that if more people are trading specific stocks, these must be those with the highest potential for current income through dividends and/or growth in value.

If you are not a fan of investing in the PSEi, you can still do passive investing by doing PCA on pooled funds. Go back to the table and see how doing a PCA on equity mutual funds had outperformed PCA on the PSEi.
So you see, Newbie Investor, investing in the stock market is not gambling if you employ the skills needed in investing, whether they are your own or those of others, and not leave everything to chance. And while there is no guarantee of success, at least the downside risk is managed.

Happy investing.

(Efren Ll. Cruz is a registered financial planner of RFP Philippines, personal finance coach, investment adviser and author. For inquiries, call or send text to 0917-505-0709 or e-mail to [email protected]. To learn more about the RFP program, visit www.rfp.ph or e-mail [email protected].)