Investing in the stock market is not an easy thing to do. Therefore, every investor should know the difference between speculation vs investing.
The truth is that most “investors” are actually speculators trying to gamble their way to achieving wealth. According to The Balance, people lose money in the markets because they let emotions—mainly fear and greed—drive their investing.
Studies have shown that a fraction of investors and speculators make money in the stock market. Professional investors, aka fund managers, also have a hard time beating the market. As an example, Warren Buffett famously bet 1 million dollars with a fund to see who could have a better return over a 10 year period.
According to Investopedia.com, Ted Seides with Protégé Partners LLC accepted the challenge with Buffett in 2008. Warren Buffett later won the bet and the results were not close. The point here is that Buffett invested with an index fund which generally tracks the market without any stock picking. The fund that lost the bet was a hedge fund, which in generally known for being an active picker of stocks.
Moreover, people tend to forget that investing is meant to be a long term strategy. That is because investing takes time. Just like the old saying goes, “Rome was not built in a day”, the best things in life always take time to build and see growth.
Therefore, it is obvious that studies show us why most investors don’t end up making money in the short term. The truth is they are not investing at all, but rather speculating with their money and without a long term plan.
Here are some other topics I will go over that suggest you may be speculating with your money:
- Buying stock with the intention of selling in the near-term
- Not thinking about the economics of the business
- No protection of principle
- Checking your portfolio everyday
- Expecting to get rich quick
Buying stock with the intention of selling in the near term
I would guess that many investors forget that owning shares of a stock is actually owning little pieces of that company. Thus, many investors have become short sided in their investment approach.
According to Yahoo Finance, the average investor holds onto a position in the stock market for 5.5 months. In the 1950s, investors averaged a position of 8 years!
If owning shares are like owning a piece of that business, investors should treat themselves as being just that: owners of a business. If I started a business in my town, I’m not going to continuously try to get a quote on that business to see what it is worth. I’m going to work on reinvesting into that business because that is how great businesses are built. This type of thinking is a key difference between speculation versus investing.
Thus, one of the biggest mistakes an investor can make is by not treating shares as what they really are-ownership in a business. By selecting a stock with long-term potential and eliminating our short-sided thinking, we can refrain from speculation.
Not thinking about the economics of the business
What does thinking about the economics of a business mean? Another difference between speculation vs investing is that investors take the time to think about the assets that a company uses to generate income.
For example, lets compare the economics of a business like Hanesbrands, which you can read about here, and that of a random pharmaceutical company. The former makes products that we use everyday. The latter is usually a company that focuses greatly on investment in R&D and also requires additional funding for its normal operations. The point is that a business like Hanesbrands produces something we all need while a pharmaceutical company does not necessarily.
One main difference between speculation and investing is knowing the facts about the underlying business of a stock.
No protection of principle
What is protection of principle?
Benjamin Graham defines an investment as “an investment operation is one which, upon thorough analysis, promises safety of principle and a satisfactory return”.
Benjamin Graham was Warren Buffetts teacher and mentor. He is widely known as the grandfather of value investing and laid the framework of how to value a stock. Notice how there is two parts to Grahams definition of what is considered to be an investment. Most of us focus on the “return” portion but lack the understanding of the “safety” aspect.
Thus, in order to define our investments as actual investments, we must focus on both parts. It’s obvious that making a generous return on our money is desired. However, without any focus on protection of principle, it will be hard to make any money over the long term.
Here are some factors that can be used for determining protection of principle:
Dividends:
Does the company pay a dividend? Dividends can not only help with your return in a strong market, but also a weak one. Look for company’s that have continuously increased their dividend over the years. This, as well as a company that has great economics, can protect you during all cycles of the market.
Management:
Generally, this factor can be a tricky one to analyze. For one, getting to know the mangers of a huge company is not something we all can generally do. Most CEO’s are not going to hand out their personal cell number for you to chat with. Therefore, when thinking about whether managers can help protect our principle, I like to look are their track record. Do they have a successful history of managing other company’s?
Price:
Lastly, but maybe most important, the price at which you purchase a company can help give protection of principle. Most investors will describe this as “buying low and selling high”. Yet, this doesn’t describe all the details needed for protection.
Looking at the market value of a company after careful analysis should give an investor an idea of what a price should be for a stock. Using the principles listed here can also help to determine the price. After looking at qualitative and quantitative factors of the company, you should have a better understanding of what it is worth.
Checking your portfolio everyday
Referring back to the article above about the holding period for the average investor gives us proof that people are checking their portfolio more often than they should.
This is a great piece of information to understand. Knowing that the average investor only holds their position for a few months explains how the markets have become very fluid. In some cases, stock ownership isn’t thought of as actual ownership in a company anymore.
One aspect of knowing the difference between speculation vs investing is knowing that investing is a game of psychology. Being able to control ones emotions will better determine the chances of success rather than having a higher I.Q..
This leads us to the final factor of speculation.
Expecting to get rich quick
This expectation is not something easily avoidable.
As human beings, we are wired to think for short term gains. It’s hard to avoid the fight or flight instinctive trait that’s embedded in all of us. Still, according to the book The Dao of Capital written by author Mark Spitznagel, “Without a depth of field perspective, we become victimized by time. Immediacy is a tyrant, ratcheting up stress and exacerbating feelings of being time-bankrupt”.
One of the best examples of this is the feeling we have of living for the weekend. Most of us work Monday through Friday and then enjoy the next two days off. This is how we live our lives. Living one week at a time. Mark argues that without planning and saving for a time in the future, we can never get out of the endless cycle of only living for the weekend.
Think of the many addictions that play a role in our lives. Drugs, alcohol and forms of gambling are always there for our immediacy. Meaning, none of these forms give us any lasting sense of fulfillment.
Ultimately, if we are going to refrain from speculation and invest our way to a better life, we have to be patient (I talk more about this principle here). Nothing with happen over night but we have to break the cycle of living for a week and find ourselves seeking long term goals.
We must have a vision of something we want to achieve in the future and work towards that goal. Yet, only by reminding our selves that nothing worth achieving comes quickly will this goal then be attainable.
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