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How to tell if you're a prudent investor or a reckless gambler

Gambling and investing are worlds apart. One could lose you all your money. The other is a slow and steady route to long-term wealth. 

Yet telling the difference between the two is easier said than done. After all, both can involve holding shares in companies or trading other financial instruments.

A new type of investment platform also blurs the line between investing and gambling, peddling high-risk financial instruments alongside safer investments.

Are you gambling? According to the City regulator, a growing number of stock market enthusiasts misguidedly think they are investing when, in truth, they are putting their savings in serious danger by taking on far more risk than they realise

For example, platforms eToro and Trading 212 allow people to purchase lower-risk tracker funds that invest in hundreds of companies around the world.

But alongside these, investors can also buy high-risk crypto-currencies, bet on currency fluctuations, or even purchase Contract for Difference (CFD) instruments that magnify their losses. More than two thirds of ordinary investors lose money when trading CFDs with Trading 212 and eToro.

According to the City regulator, a growing number of stock market enthusiasts misguidedly think they are investing when, in truth, they are putting their savings in serious danger by taking on far more risk than they realise.

Sheldon Mills, executive director of consumer and competition at the Financial Conduct Authority, says: 'We are worried that some investors are being tempted – often through online adverts or high-pressure sales tactics – into buying higher-risk products that are very unlikely to be suitable for them.' 

The FCA does not mention any companies by name. So how can you tell if you're gambling or investing? The answer is often surprisingly counterintuitive. But here are a few of the tell-tale signs.

Do your investments keep you awake?

Investing shouldn't give you an adrenaline rush – or cause you serious worry. If it does, you're probably gambling or trading, not investing.

For an increasing number of people, getting into investing for the first time, emotion and thrill are key to the experience, according to research by the regulator.

But if your investments are keeping you awake at night with worry, you are probably taking on levels of risk more akin to gambling than investing. And by the same token, if you are experiencing extreme highs and lows, you are probably gambling.

New breed of investment platforms: eToro and Trading 212 allow people to purchase lower-risk tracker funds, but alongside these, investors can also buy high-risk crypto-currencies

Bimpe Nkontchou is founder of digital wealth management platform Wealth8.

She says: 'While some investors enjoy the thrill of short-term stock trading, riding the wave with the hope of a lucky win, it's a recipe for disaster, especially if you stake large amounts that you cannot afford to lose.

'Investing means taking a slow and steady approach, picking a well-diversified portfolio of investments to hold over the long term. Investing regular amounts every month and reinvesting any dividend income is a better and safer method of building wealth – instead of the 'get-rich-quick' approach of gambling.'

Are you listening to your gut?

There are some areas of life when following your instinct can help you make the right decision. Investing is not one of them. If you are relying on your gut when trading, you may be taking on too much risk – or even gambling.

Anna-Sophie Hartvigsen is co-founder of financial start-up Female Invest.

She warns investors to be wary of gut feelings. 'Investing is based on rational decisions for the long run,' she says, 'whereas gambling is typically a short-lived activity based on gut feeling and luck.

'Looking at historic investment returns, the global stock market increases around ten per cent a year on average, whereas gambling has a negative expected return.'

She adds: 'You get the best chance of a high return if you invest based on rational decisions rather than irrational feelings.'

Even professional investors don't have reliable gut instincts about when to buy and sell

Even the best professional investors do not have reliable gut instincts about when to buy and sell. In fact, what feels like a gut instinct can be one of several behavioural biases, which delude us into thinking we know what the future holds.

For example, if the share price of a company has been rising for some time, we are more likely to believe it will continue to do so.

Investors also unconsciously follow herd mentalities. Our instinct tells us to sell because everyone else is – even though this could mean selling when prices are low. And our gut can tell us a company is a good buy because there is a buzz around it – even if that buzz has pushed the share price up to unsustainable highs. 

However, don't ignore your gut instinct completely. Do take heed if it warns you that an investment sounds too good to be true or that something seems suspicious. It could just stop you from falling for a scam.

Is your portfolio taking up a lot of your time?

As a rule of thumb, the more time and effort you put into something, the better at it you are likely to become. However, this rule does not apply to investing.

If you are spending time every day or even every week tweaking your portfolio – buying and selling – you are more likely to be gambling or trading than investing. The result will be lower returns.

Dan Lane, senior analyst at investment platform Freetrade, explains that inaction is often key to investment success. He says: 'Train yourself to recognise that investment success isn't about who can buy and sell the most assets. In fact, it could be the opposite.

'If you're putting effort into finding out which companies are run well and consistently making money, why would you then want to sell them?

'You're ignoring the potential long-term benefits, not to mention you have to go out and find something better to put your money into.

'This unveils the real truth about investing. You don't necessarily make money selling a quality asset – you make money owning it. The longer you give dividends from good quality assets time to snowball, the more chance you have of racking up long-term gains.'

Are you excited about a handful of companies?

Finding companies that are going to change the world can be an intoxicating experience.

But if you are aligning your financial future with just a small number of shares, you are likely to be taking on a lot of risk.

If those companies are new and unproven, your investments may be no safer than gambling.

'If Tesla is one of the only companies you've invested in, then you could be taking more of a risk than you realise', says Rachel Rickard Straus

The Financial Conduct Authority warns that high-risk investors are likely to enjoy the status that comes with a sense of ownership over companies they invest in. But it's a risky strategy.

It may sound more glamorous to tell people you are an investor in electric car manufacturer Tesla than in a diversified portfolio of investment funds and shares.

But if Tesla is one of the only companies you've invested in, then you could be taking more of a risk than you realise.

Heather Owen, a financial planner at Quilter Private Client Advisers, adds: 'The first rule of investing is to diversify your portfolio to reduce the risk.

'Buying one single stock is very high risk as you put all your eggs in one basket.

'Back lots of horses and then if one falls, you know you have a back-up. Diversification extends beyond just shares.

'Having a diverse portfolio of assets – including bonds, property and alternatives – is also a good way to go.' 

... but you can still find it thrilling 

For most people, good investing should be boring. It should be slow and steady with rewards reaped over decades, not weeks.

The exciting bit should be the outcome – the first home, or the richer retirement that investing bankrolls – rather than the process.

Understandably, many investors enjoy the excitement of investing itself. After all, testing your stock-picking prowess and predicting the latest market trends can be thrilling.

For these investors Rob Smith, head of behavioural finance at Barclays, suggests a compromise.

He says: 'One option is a core-satellite approach. Investors could put the majority of their money for the future into something stable and boring.

'Then they add a small, satellite component of investments that gives them more enjoyment, keeps them engaged and gives them emotional reward – but without derailing their longer term financial plan.'

That means you can still enjoy the status of being an investor in the companies you most admire – and the rush of seeing their share prices rise and fall.

This approach may also help you to learn tough lessons that will help you become a better investor in the long term. 'Personal experience is one of the best ways to learn,' says Smith. 'People often say that you can learn from others' mistakes. But the truth is that investors tend to be over-confident and think they won't make the same mistakes as everyone else.'

Smith cites the example of queuing at a cash machine when the person in front of you turns around and says it is not working.

Most people will still try out the machine nonetheless, believing they will have more luck than the person before them.

'Nothing can reproduce the experience of doing something yourself,' says Smith.

'When investing, you want to be able to make your own mistakes without suffering huge financial losses.'

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