Are you investing or speculating?
When you last bought a parcel of shares, were you investing or speculating? The term speculation carries some negative connotations, evoking thoughts of risk and recklessness, and is probably not one many of us would want to identify with. It’s a distinction that often arises in financial journalism and marketing, with money managers typically laying claim to the investor label to convey that what they are doing is good, wholesome and professional, and not prone to misadventure.
But where exactly is the line between speculation and investment, and how do you tell which side you’re on?
Unfortunately, the definition itself is a bit unclear. The Oxford English Dictionary suggests that speculation is the investment in stocks, property, etc. in the hope of gain but with the risk of loss. On that basis we are all speculators.
When finance professionals use the term however, they are usually drawing a distinction between buying an asset in the hope of profiting from movements in its price, and buying an asset in hope of benefiting from the underlying attributes of the asset. In simple terms, buying a cheap stock with a view to selling in down the track when it is fully valued is speculation. Buying the same stock purely to benefit from the stream of future dividends is investing.
There is a powerful concept implicit in this distinction: the idea that owning a stock can be its own reward, irrespective of what happens subsequently in the equity market. For a true “investor”, a crash in the stock market is more likely to be a good thing than a bad thing, as the loss of market value of their holdings is of no concern, especially when the opportunity arises to acquire additional dividend streams on favourable terms.
The GFC was some years ago now, but many readers will recall the stress and anxiety it provoked, and the wholesale abandonment of the equity market by disappointed shareholders in the wake of the losses. Imagine being able to sail through a period like that and view it as a positive thing.
Of course, none of us live forever, and in reality most investors remain conscious of the market value of their holdings. However, it is worth reflecting on the distinction between speculation and investment. If you can adopt a little more of the mindset of the “investor” in your stock market deliberations, you may be much better placed to weather the next storm when it comes. And it always does.
Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To invest with Montgomery domestically and globally, find out more.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Evan
:
Hi Tim,
It’s worth noting that Benjamin Graham has a different (and probably more comprehensive) definition of investing:
”An investment operations is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
Note that this covers cases in which an investor buys a stock because it has a large unsustainable dividend yield, which would likely lead to a revaluation downwards, while your definition doesn’t. In fact, Graham would call those investments speculative even though the aim is income.
Another issue is that the definition you cited would exclude most value stocks (Low PE, PB, etc) since many these days don’t pay a dividend. In fact, very few stocks would be characterized as investments under that definition.
This is the first comment I’ve posted on the site but I’ve been enjoying the articles for a while now.
All the best,
Evan
Roger Montgomery
:
Thanks for taking the time to contribute Evan.
Steve Greenwood
:
Hi Tim
Thanks for this article. It’s good timing as my 14 yo has a school project with $50 k play money to “invest” with. It’s a 10 week competition that appears to be organised by the ASX for school groups. The school team that makes the most wins a prize! I’ll let him have a read of your article…but with just 10 weeks, you can imagine the high risk speccys that might come into play here.
BTW, thanks for the annual letter to investors. I get a lot of comfort from your conservative long term approach and choosing not to lower the discount rates you apply to company valuations in the current interest rate environment.
Hedley Calvert
:
I can relate to Tim’s comments above. A major shift happened a few years ago when I set up a SMSF. This forced me to start thinking in terms of investing for a +20 year period. I stopped chopping and changing share holdings based on the latest recommendations and now look forward to market meltdowns. It’s easy to read about Warren Buffet but much much harder to live it. It took over 20 years of speculating to finally become an investor….and it’s a much happier place.
Phil WASER
:
Hi Tim, for many, many years I thought that I was investing but I simply didn’t know what I didn’t know. It was akin to the person who thought he’d been swimming at Bondi beach but realised that he’d only been going through the (sewerage) motions before they upgraded the outfall there. Now I have given the money to my Wife and she is truly invested in the Montgomery Fund and The Montgomery Global Fund and we enjoy a much better lifestyle. Thanks to all the wonderful Montgomery team…
Tim Kelley
:
Thanks for that Phil. Glad we could help.