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Risk to Reward – Don’t Gamble… Invest

“I just won $10,000.”

“I doubled my money on one stock.”

“I bought a lottery ticket for only $1 and won $1 million.”

It’s hard not to be envious when you hear these stories… Even after adjusting your expectations.

But with want I’m about to tell you, you’ll breeze by these stories.

You hear big-win stories all the time… but they’re rare events.

A smart investor’s first question is almost always… “What was the cost and chance of winning?”

This question helps investors focus on risk to reward. Smart investors gravitate towards trades that limit risk and maximize reward.

Gambling for instance is when the average reward is lower than the average cost. In other words… the odds are against you.

For example let’s look at a $1 million lottery. Tickets cost $1 and there can only be one winner. Now let’s assume two million people pay for a ticket.

If you bought every ticket to guarantee a win, you would spend $2 million and only win $1 million. So if you play the lottery indefinitely you will receive only $0.50 for ever $1 spent.

On top of winning, the government will take a large portion in taxes. Many people overlook this caveat that makes your risk to reward worse.

To put winning a big lottery into perspective, just remember… you’re more likely be attacked by a shark or be killed by a hippo.

Many investors avoid lotteries but still fall prey to gambling. Penny stocks are a prime example.

Penny stocks lack oversight and investor protection. Insiders often trade penny stocks based on information that the public can’t access… This pushes odds further against outside investors.

It’s best to keep clear of investments that lack clarity.

Investing, opposed to gambling, is when the average reward outweighs the cost/risk. You expect a positive return.

With history as a guide, we can expect the S&P 500 to return about 8% annually.

 

Published in Training Center