We often speak with clients who have the sneaking suspicion that their previous investment firm was essentially gambling with their money. The unfortunate truth is that many investment professionals might as well be called what they really are – sports bookies.
Though these two lines of work may seem quite different on the outside, you might just be surprised at the similarities – and at how the “beat the market” strategy endorsed by so many investment professionals is simply gambling in disguise. Here's Part One of a two-part series on the similarities between investment brokers and sports bookies -- and why you should seek strategic financial planning and wealth management strategies from a wealth advisor, instead.
Your Financial Planning Consultant Shouldn't Also Be Your Bookie
Though with a few exceptions, economists’ reputation may be just a little lower on the “glamor and excitement” scale than accountants’, you might actually be surprised at some of the realms in which economists travel when they’re engaged in testing and applying theory.
One such place is the wild world of sports betting. Why? Because point spreads are equivalent to stock prices. Here’s why this analogy works.
In his article “The Economics of Wagering Markets,” author Raymond Sauer states that:
“Although these markets are a tiny feature of most economies, they present significant opportunities for economic analysis. These stem from the fact that wagering markets are especially simple financial markets, in which the scope of the pricing problem is reduced. As a result, wagering markets can provide a clear view of pricing issues which are more complicated elsewhere.”
Clearly, sports betting serves as a microcosm of the financial markets. And while gambling is a zero-sum game -- what one player wins, another loses – and investing is a positive-sum game, a number of interesting parallels exist between wagering and investing in the stock market.
Wealth Managment Is Not a Game
Let’s focus on betting on National Football League (NFL) games. If you’ve ever wagered on NFL games, you know how difficult it is to win consistently. But why is that? Most of the time, there’s a favored team and most of the time, they win.
So why not just bet on the favored team all the time? The more you bet, the more you’d win – right? Not exactly. The answer is a bit more complex, because it involves a little thing called a point spread. For instance, if the Seahawks have a better record than the Bears, you can’t just bet that the Seahawks will win. Instead, you’ll have to give up some points. For instance, the Seahawks may have to win by 7 points in order for you to win. Think of it as a golf handicap.
Now enter the bookies. They act as go-betweens, matching bettors who are backing one or the other competing teams. Bookies don’t have any interest in taking a net position; in other words, they don’t want to place any of their own money at risk. Their responsibility lies in setting a point spread that balances the bets on each team.
Bookies vs. Wealth Management Advisors
Bookies may set the spread a week before the Seahawks-Bears game, but that spread isn’t set in stone. Perhaps Russel Wilson hurts his knee during practice that week. Perhaps the bookie simply sets the spread incorrectly and too many people bet on one team. When that happens, bookies adjust the spread during the week. This challenge is similar to those that underwriters face when setting a price for an IPO.
Think of the point spread as a flexible price – or an equilibrium price – that balances two opposing forces and equalizing two populations, in this case, those betting on the bears and those betting on the Seahawks. More precisely, the point spread equalizes the dollar amount wagered on each team.
The equilibrium spread “clears the market,” ensuring that there’s no shortage of Seahawks bettors or Bears bettors. In econ-speak, the two sides of the wager are analogous to supply and demand. Flexible prices equalize the quantity supplied with the quantity demanded, just as the point spread equalizes the amount wagered for and against a particular team.
In Part Two, we’ll explore what investment professionals and bookies have in common – specifically, how they’re gambling with your money.