PDSnet | Articles

Gambling Vs. Investing

25 October 2018 By PDSNET

GAMBLING Gambling is associated with casinos and is epitomised on the roulette table. In roulette members of the public essentially bet against each other with the casino taking a small percentage for the cost of setting up and running the table. There are 37 numbers on a roulette table – three rows of twelve numbers plus the zero. If you place a R10 bet on every number you will have to outlay R370 – and then you can be certain to win because one of those 37 numbers must come up. Except that when you win you will only be paid out R350, plus the R10 that you bet on the winning number. In other words you will get back R360 for your R370 bet – the other R10 (approximately 2,7%) is kept by the casino to meet its costs and make a profit. That is gambling. And the simple fact of the matter is that the longer you play roulette, the more you will eventually lose – but that does not mean that you will lose on every spin. It just means that the odds are stacked against you so in the end you will always lose.

TRADING

Trading in derivatives is exactly the same as the roulette table. Basically, the public are betting against each other with the derivative market taking a small percentage to cover its costs and make a profit. This includes all types of derivatives – futures, options, single stock futures, Contacts for difference (CFDs), currencies, binary options and any other instrument which derives its value from an underlying security of some sort. They are all what can be called “zero-sum-games”. In other words, if you add up all the winners and subtract all the losers, you will come back to zero – with the market taking off its slice to meet costs and make a profit.

INVESTING

Investing is different from either gambling or trading because when you buy a share in a good quality company you are investing in the ability of the company’s board of directors to grow that business over time to generate good profits and pay good dividends. Every day those directors go to work with the sole objective of growing that business by expanding its scope, reducing its costs and improving its margins. The only risk you are taking is that they will not be good at it. You are basing your investment entirely on their competence and ability.

PATIENCE

So the essential difference between investing and gambling or trading is one of time. The gambler or trader is after a “quick fix”. He wants to make money now – or at least very quickly. He has no patience. The investor, on the other hand, is prepared to wait patiently for his investment to bear fruit. He is patient and careful in his assessment before buying a share and then prepared to wait for years while his investment grows steadily. The simple truth is that wealth cannot be created quickly and anyone who tries to persuade you that it can is simply trying to earn a commission from you and has no interest in your ultimate success.

CREATING WEALTH

So, once you have wasted money on gambling in derivatives and you have learned the truth of what is set out above you will be ready to learn how to create real wealth through care and diligence and patience – exactly like Warren Buffett, the most successful investor who ever lived, has done over the past 60 years. You need to look for what we call “diagonal shares”. These are shares which just keep on going up through thick and thin. Their charts go from the bottom left-hand corner to the top right-hand corner of your screen – that is why they are called “diagonals”. Consider the semi-log chart of Santam over the past 33 years:

Santam (SNT) Semi-Log Chart February 1985 to October 2018 - Chart by ShareFriend Pro

Here you can see that this share has just kept on going up despite all the wild gyrations of the South African economy over that time and the impact of international melt-downs like the 1987 crash, the 1998 dot com crash and the 2008 sub-prime crisis. This share has gone up from 90c per share to its current price around R300 – and every year it has paid out good dividends to investors. So you need to ask yourself why you would ever consider selling such a share?

TAXATION

And then, finally, there is the question of taxation. In South Africa we are subject to capital gains tax (CGT) – which is effectively 16,4% of any capital gain that you make when you sell a share. But this does not apply to traders of derivatives. They are automatically considered to be “dealers” by SARS and whatever gain they make is added to their taxable income in the year when they make it. This means that they will pay whatever their marginal tax rate is on that capital gain – which could be as much as 45%. We suggest that this is a very important consideration. If you intend to make money from your capital then you would obviously prefer to pay 16,4% than up to 45% on your capital gain. SARS has a rule that if you hold a share for three years or longer you will definitely never be declared to be a “dealer” and you will be taxed at capital gains rates. For this reason, we believe that you should always invest with a three-year horizon. Ask yourself where that share will be in three years’ time – and base your decision on that.