Part III · Chapter 8 · Claims · lesson 8
Three activities that look identical from outside
13 min
Builds on Diversification stops working when you need it
Part III · Chapter 8 · Claims · lesson 8
13 min
Builds on Diversification stops working when you need it
Three people put 10,000 into three different things on the same Monday. All three are hoping to have more later. From the outside the transactions are indistinguishable, and two of them will describe what they did using the third one's word.
The distinction is not about respectability, sophistication, or how much research was done. It is about where the return is supposed to come from.
Investing. The return comes from something producing. Profits, rent, interest, harvests. Everybody holding productive assets can be paid at once, because the payment comes from output that did not exist before.
Speculation. The return comes from a change in price. Someone else pays more than you did. Before costs this is close to a transfer between participants: your gain has to be somebody's foregone gain or loss.
Gambling. The return comes from a manufactured random event, priced so the house keeps a share. The sum across all participants is negative by construction, and no amount of skill changes the construction.
None of the three is a compliment or an insult. They are descriptions of a mechanism, and the reason to name yours correctly is that each one wants different position sizing.
Take the three definitions seriously for a moment and something useful falls out.
If the return comes from production, then the pool of returns grows over time and all participants can be up together. Being average is a perfectly good outcome; you did not need anyone to be wrong.
If the return comes from the price, the pool does not grow on its own. For you to be up, somebody has to have been on the other side. Being average is therefore break-even before costs and a loss after them, which means the activity only makes sense if you have a specific reason to believe you are better than the person opposite. That reason has to be nameable.
If the return comes from a house game, the pool shrinks by the house's share every round. Being average is a steady loss, and the only winning move over enough rounds is not to play — which does not make it irrational to play, it makes it entertainment with a price, which is a completely legitimate thing to buy.
Not the same thing
Buying a claim on something that produces, and being paid out of the production.
Buying something in the expectation that the price will be higher later.
Which is which? Put each one on a side.
Buying a share of a business that pays out steadily, planning to hold for the payments
Buying a currency because you expect it to strengthen over six months
Lending to a business at a fixed rate, intending to hold to maturity
The line between speculation and gambling is not about how risky the thing is, which is the assumption most people arrive with.
A speculative position can lose everything, and a casino game can be low-stakes and mild. What separates them is whether the risk existed before you arrived. The price of a currency, a commodity or a company exists whether or not you participate; you are taking on a risk the world already contained. A roulette wheel manufactures a new, previously non-existent uncertainty for the purpose of transferring money, and charges a fee for spinning it.
That is the actual boundary, and it has a useful consequence: a financial product whose payoff depends on a manufactured event, priced with a margin for the party offering it, is a house game wearing a financial costume no matter what it is called.
What would you do
What would you do
Check