Investing vs. Speculating
I've recently been rereading Benjamin Graham's 1949 masterpiece, The Intelligent Investor. If this is a book you've never read yourself, I highly recommend picking up a copy. Warren Buffett calls it, “By far the best book on investing ever written.”
Graham's approach to investing is very levelheaded. He generally preaches investing in securities that appear underpriced by some form of fundamental analysis. And he opens the book by differentiating between investing and speculating.
We often use the words “investing” and “speculating” interchangeably. But there are significant differences. Many would say that speculating simply involves a higher level of risk. And while that's true, the differences don't end there.
An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.
Let's break this down...
There are three elements of true investing that Graham is pointing out here:
- Analysis: Scrutiny of a business's underlying value
- Promises safety of principal: Protection against capital losses
- Adequate return: An acceptable (not extraordinary) ROI
Anything else, Graham says, is speculation.
An investor figures what a security is worth based on the underlying value of the business. A speculator, on the other hand, is simply betting that someone else will be willing to pay more it in the future. They basically play the “greater fool” game.
As Graham puts it, investors determine “the market price by established standards of value.” Conversely, speculators “base [their] standards of value upon the market price.”
Let me clean that up a little bit...
Investors base market price on value.
Speculators base value on market price.
Confusing investing with speculating can be a costly mistake. And we really don't have to look any further than Bitcoin to see that.
Last year, the market went wild for Bitcoin and cryptocurrencies. The price of Bitcoin shot up to nearly $20,000. I remember the day back in December when the price of Bitcoin would go up another $500 every time I hit the refresh button on my browser.
Everyone was talking about Bitcoin and cryptocurrencies, and many were buying, even though very few people even understood them. Hell, people couldn't even agree on whether Bitcoin was a currency, a commodity, or some other form of asset. They still can't.
This was a classic example of speculating. And for many, it blew up in their face. Bitcoin has lost some 66% of its value since.
Most people look at the stock market as some kind of get-rich-quick scheme. And once they try that, they find out it doesn't work that way.
Investing — true investing — is like playing a game of football. It's a slow game of moving the line forward. You don't win the game by throwing Hail Mary passes every time. In fact, that's a great way to lose the game.
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There's no doubt that speculating is way more exciting. And if you get lucky, speculating can be extremely rewarding. But it's also one of the worst possible ways to build wealth over the long term.
Now, I'm not saying you should never speculate. Instead, you should speculate wisely. Having a bit of high-risk exposure is not a bad thing. But risk should absolutely be balanced with safety.
Truth is, the human being loves to gamble. And Wall Street knows this. Wall Street loves to downplay the durable virtues of investing in favor of the appeal of speculation. Why? Because they don't care whether or not you make any money, as long as you keep trading.
This fact is parodied in the 1983 Eddie Murphy/Dan Aykroyd classic comedy Trading Places.
Randolph Duke: Some of our clients are speculating that the price of gold will rise in the future. And we have other clients who are speculating that the price of gold will fall. They place their orders with us, and we buy or sell their gold for them.
Mortimer Duke: Tell him the good part.
Randolph Duke: The good part, William, is that, no matter whether our clients make money or lose money, Duke & Duke get the commissions.
Speculating lowers your odds of building wealth and mostly serves to line the pockets of brokers. Investing, on the other hand, works for you.
Don't fall for the glitz, glamour, and hype of short-term gains from speculation.
Play the long game of investing.
If you're interested in learning more about value investing, I highly urge you to check out Charles Mizrahi's Park Avenue Investment Club. He has dedicated his entire 35-year career to these principles and was ranked the #1 performing market timer, not just on Wall Street but in the entire United States, based on the actual performance of client accounts.
Until next time,
As an editor at Energy and Capital, Luke’s analysis and market research reach hundreds of thousands of investors every day. Luke is also a contributing editor of Angel Publishing’s Bubble and Bust Report newsletter. There, he helps investors in leveraging the future supply-demand imbalance that he believes could be key to a cyclical upswing in the hard asset markets. For more on Luke, go to his editor’s page.
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