Weekly comment - February 9, 2021

Feb 09, 2021 | Nick Foglietta


Take personal inventory as to how much “mental and emotional capital” you are spending on the stock market today. Be honest with yourself.

Gambling vs. Investing

In all of my career, the last nine months have been the toughest fighting the urge to gamble.

With speculative stocks running wild, the desire to overplay my hand and trade overvalued pieces of garbage, rather than invest, was intoxicating.

On a number of occasions, in my personal holdings, I was over the line in both, amount of money gambled and long term risk tolerances.

I let greed and “fear of missing out” (FOMO) get the better of me.

It was time for me to stop and I did, on February 3rd, 2021.

This editorial will share what feelings drove my behaviour and why I knew was time to stop.

But, before I begin I want to thank a dear friend and client who took the time to share her expertise in addictions and how it can apply to investors/speculators. Thank you Michelle.

So, how can one know if they are investing or gambling?

To begin this discussion, let’s be clear that all investing carries an inherent level of risk.

Owning volatile stocks is obviously risky.

Owning conservative stocks carries a lesser level of risk.

Owning real estate—especially leveraged real estate—has its own level of risk.

Most would intuitively acknowledge this to be correct.

But owning GICs, short term bonds, or even cash is risky too. Here the risk is not always in terms of market value, but in long term purchasing power.

Therefore, all investing is risky.

The idea behind a portfolio of assets, is to hold some things that go up at the same time as other things go down under similar economic conditions, also known as diversification in “non-correlating assets” to alleviate risk.

Nobody knows the future with certainty, so this gives your asset base robustness, and allows it to do its job of maintaining its purchasing power in a greater number of financial situations.

The ideas above are what investing is all about, but how different is that from gambling?

The rest of this comes from my own personal experience; can’t say it is the definitive experience, but I believe it might help you see the difference.

When I am investing, I don’t really care what the price of my investments are each and every day. The thoughts that come to my mind are more to do with value, cash flow, rebalancing over time.

Expectations are not to get rich quick, but to participate in the long term advancement of the assets held.

As an investor, I might look at the portfolio once a week, month or quarter, and maybe it needs rebalancing twice a year back to the original asset mix.

Investing does not expend a lot of mental or emotional capital once the ground work is put in place at the beginning when making the investment selections.

It is much like gardening, in that you work hard to prepare the land and sow the seeds, so that you just need to water and weed the garden on a regular basis.

Gambling, on the other hand, is exciting, emotional and completely occupies your thoughts if your bets are large enough.

Imagine that you invest 40 per cent of your portfolio in volatile stocks.

These stocks tend to move in the same direction on any given day by as much as 20 per cent. On good or bad days, your total portfolio is changing in value by as much as eight per cent! Get three bad days in a row and you have lost 21 per cent of your money on paper.

That is stressful!

Of course the opposite is also true.

The news is filled with stories of people making insane rates of return on their money by gambling in stocks. This is where the “fear of missing out” comes into play.

Let’s drill down a little deeper.

You put 40 per cent of your portfolio in volatile stocks. Maybe you buy five stocks in total. Two of the stocks go down, one stays the same, one goes up and the last one goes up a lot.

You decide to sell your two “losers” plus the unchanged stock and add to the winner going up a lot.

You added to the winner at $32.00 and $45.00. The stock has now gone from your original purchase price of $15.00 to $75.00 (400%) in four months.

Great right?

Well yes, absolutely, but now you are way out over the tips of your skis in terms of concentration risk and volatility.

The original stock position you purchased now represents about 30% of your portfolio valuation, but because you added your losers to it, the actual percentage is nearer 45. This stock moves up and down on any given day by plus or minus 10 per cent and, therefore, your daily net worth moves by nearly five to seven per cent, per day.

Those types of numbers will keep you from sleeping at night and focus your attention each and every day.

This type of price action, when it goes in your favour, will make you crave more of this type of action. It will elicit all of the same physical and neurochemical reactions as casino gambling at high stakes. It will become addictive…

This is where my friend Michelle, mentioned earlier, nailed it for me.

Written in her email during our correspondence, the paragraph below struck me:

When it comes to the addiction part of it, there is something called "addictive liability." So not all drugs behave the same - for example heroin and most of the opiates have a high addictive liability, as compared to marijuana. Perhaps the same is true with the type of the investing (gambling) that is being done? And of course a big factor is the person that is doing the investing and what their objectives and motives are.

In the world of gambling, money is the substance and as I am sure you would agree, people/society has an interesting relationship with money. One of the things that differentiates gambling/potential addiction from substance use/potential addiction is once someone has taken their drug of choice and it's gone, users do not try and get it back. It seems to be different with problem gamblers in that they often want to get back money they have lost which can create all kinds of problems. I am not sure if you see any similarities to that in investing (gambling)?

Honestly, for long term investing the similarities are not there, but I see so many similarities to gambling in stocks that it makes my head hurt.

As in the example used above, on the way up in price, the stock becomes the center of attention in the gamblers life.

Gamblers are reinforced by positive price action and continue to do research to seek out stories that reinforce their reasons to hang on and participate in more gains.

If the stock suddenly stops performing and trades in a range, they will seek another stock that will go up like the previous one did to recapture the feeling.

When the stock goes down, they will want to get back the money by making similar asymmetrical bets with their remaining capital.

The real killer in stock gambling is buying the dip of the bubble stock that if finished its bubble phase.

When a speculative stock goes from $15.00 to $75.00, it creates a positive mental attachment with the gambler and they internalize asymmetrical risk only in the positive direction.

Therefore, when it falls, the gambler will often add even more money to the trade waiting for the rebound. If it is a bubble stock and the bubble phase is over, the stock will not recover and even more of the gambler’s original stake will be lost in the price decline.

At the end of the day, this behaviour is gambling…plain and simple. It will destroy a portfolio over an entire business cycle, if not reigned in.

The trading world in 2021, is very different from only 20 years ago, in terms of access to gambling in markets.

People can sit and privately gamble in stocks all day long on their phones.

The discount brokerages allow people to trade in options and employ leverage with virtually no due diligence or warning to the gambler of the risks.

Ironically, these gamblers are not aware of how they and their habit have become the source of great riches for those on Wall Street. That is a story for another day, but it is the truth.

This letter goes out to about 400 people per week. About half of those are clients. I have no idea how many of the people reading this comment are presently gambling on stocks in some capacity. I imagine quite a few.

May I make a humble suggestion?

Take personal inventory as to how much “mental and emotional capital” you are spending on the stock market today.

Be honest with yourself.

And ask this question: Is it worth it?

What would happen if the BULL market ended, like it did in March 2020, right now…without the snapback recovery? Do you really have a plan for how to manage risk throughout the entire cycle?

The time to ask these question is now, when things are still “bubbling along.”

One last comment:

This is not meant to be a call on what the stock markets are going to do in the near term.

My personal reasons for stopping the gambling on stocks right now are NOT centered on the conviction the stock market is about to drop. This is about doing for myself what I do for the vast majority of you…that is, invest for the long term.

Please don’t hesitate to reach out if you’d like a call to discuss your portfolio or share your comments. Looking forward to your feedback and retorts. Have a great week!