Let's Be Honest: Are You an Investor or a Speculator?
What separates an investor from a speculator?
With the S&P 500 closing at all-time highs, this is a crucial time to clarify the difference between investing and speculating.
Source: S&P 500 Chart Business Insider
Of course they look different. While an investor is generally calm and composed, a speculator is mostly excited!
Every asset is an investment in some people’s hands and a speculation in others’. So it isn’t what you buy, but rather why you buy, that determines whether you are investing or speculating.
In his classic 1934 book “Security Analysis” and again in “The Intelligent Investor” (1949), the father of Value Investing Benjamin Graham wrote: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory or adequate return. Operations not meeting these requirements are speculative.”
1. Thorough analysis
Investing requires hard work. It requires you to do a careful analysis of companies whose stocks you are looking to buy. Investing simply because someone recommended you to buy a stock without performing your due diligence work is not investing, is speculating.
You shouldn't buy or sell any stock without first performing your due diligence analysis. Do your homework and research work. Independent thinking is a required skill if you want to become a successful investor.
Also, if you’re taking advice from any intelligent financial advisor you also need to do a thorough analysis and understand if the advisor is really trustworthy or not.
The underlying fact is that this world is full of bad companies and unethical advisors. It’s your responsibility to be thorough in your analysis as to where you’d be comfortable putting your money.
Remember, it’s your money and you’ve worked hard at earning it. So be very careful.
2. Safety of capital
As mentioned by Warren Buffet, the two, and only two rules of investing are:
Don’t lose money
Don’t forget the first rule
Realize that an insatiable appetite for more will push you to the point of regret. As an investor, the safety of your capital must be your primary goal. Remember your only goal of investing in stocks must be to maintain your purchasing power in the long run, and for this, you must ensure the safety of your capital.
Also, avoid envy and fear of missing out. Just because someone else is making a 50% return annually doesn’t mean you need to be unhappy with what you’re achieving. If you buy because you are afraid of being left behind if stocks keep booming, you are speculating.
3. Adequate return
For Graham, an “adequate” or “satisfactory” return meant “any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence.”
For instance, the historical average return of the S&P 500 is around 8% to 10% annually. Any return close to or above the historical average should be considered a great victory.
Now you may ask, is anyone willing to accept a low return from stocks? Isn’t investing in stock markets all about earning high returns?”
The paradox of “adequate return” is that when you aim for adequate return (after having used reasonable intelligence while buying stocks), you will end up with an outstanding return.
Look at Warren Buffett who has been aiming for a 15% annual return over many decades. His current track record suggests that his track record stands at 20% annual return over 55 years.
Now how much does a 20% annual return amount to over 55 years?
Well, if you had invested $1,000 in Berkshire Hathaway stock when Warren Buffet took control of the company in 1965, and never sold any stock, at the end of 2020 your initial investment was worth $22,644,802.
Source: Own elaboration
Isn’t that adequate?
Final Comment
There is nothing wrong or with speculating. Everyone is free to do what they want with their money. After all, there is an element of the speculator in everybody. However, be aware of it. It’s really important to know when you’re investing and when you’re speculating.
Why does it matter?
If you think you are investing, when in fact you are speculating, a collision with reality could hurt you and encourage you to make bad decisions.
If with stocks at record highs, you buy an index fund because you think that is a safe way to earn annual returns of at least 8%-10% a year, then you are speculating. If, on the other hand, you buy an index fund knowing that stock prices are high and future returns could be lower as a result, then you are investing.
If the market’s rise makes you worry and you look to rebalance your portfolio by selling some of what has gone up and buying some of what has gone down, you are investing.
So, given the above discussion, who do you think you are – an investor or a speculator?
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Thank you for your support, and all the best in your journey to become a successful investor.
Yours truly,
The Buddhist Investor
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