It’s not about knowledge of expected returns
What we think of as investments are often more opaque in terms of understanding the odds. I know precisely the odds on a roulette table, but not a stock investment. In fact, knowing the precise odds is often a prerequisite of gambling.
It’s not about positive expected value
If a lottery pool gets big enough such that there’s a positive expected value, it doesn’t cease being gambling. Similarly, insurance almost always has a negative expected value but is still a part of an effective investment strategy.
Positive expected value isn’t the end-all be-all in investing. It’s about transferring wealth between potential states. Consider the case of the positive expected value lottery.
Suppose the payout of a lottery is $1 billion, odds of winning are 1 in 500 million and tickets are $1. So the expected value of a $1 lottery ticket would be $2:
return = probability(win) * payout
2 = 1 / 500M * 1B
Should you spend 1 million lottery tickets on this great return?
Buying 1 million lottery tickets would result in being $1 million poorer in 499 scenarios and $1 billion richer in 1 scenario. Technically a positive sum payout but it ignores the lopsided distribution of outcomes.
You can use Kelly Criterion to calculate optimal bet size:
percent_wager = (prob_win * payout_perc - (1 - prob_win)) / payout_perc
(1 / 500M * 1B) - * (1 - (1 / 500M)) / 1B
Percent you should wager: 9.99999998 × 10^-10
Despite the positive odds, the optimal bet size is so small as to make the game unplayable.
Its not about optimal bet size
Many investments require significant stakes and active attention. If someone starts a business, it’s likely that much of his wealth is tied up in that business. For instance, the overwhelming majority of Bezos’ wealth is tied up in Amazon. Same is true for most of the wealthiest people in the world. Are they just the luckiest gamblers? Is the person running your local laundromat a degenerate gambler?
It’s not about zero sum returns
Most gambling is strictly zero sum. The loser transfers X to the winner. But depending on how you look at it, investments are the same. A buyer and seller transfer some amount to each other. If you consider opportunity cost and a time horizon, the future value makes one party poorer at the expense of the other.
Some investments do have positive sum though. I can invest in a canvas and create a work of art that sells for considerably more than the raw materials. But gambling can be said to have positive sum as well since the monetary transfer is just one part. Surely, people get something out of gambling, otherwise they wouldn’t do it.
It’s not about skill required or chance
There’s no skill in investing passively in a 401k. There’s plenty of skill required in sports gambling. And both have a high degree of chance.
Why do we distinguish between gambling and investing?
The only reason I can come up with is a moral one:
Gambling is bad and should be avoided. Investing is good and should be encouraged.
I can’t think of a meaningful distinguishing characteristic that fits my priors (gambling: casino, lottery, sports, meme stocks; investing: pension fund, insurance, ETFs) . That doesn’t mean the paradigm isn’t useful. The best I can come up with is Justice Potter Stewart’s quote when describing his threshold test for obscenity in Jacobellis v. Ohio:
I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description ["hard-core pornography"], and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.