By Kevin M
How is it, that when we put money into commodities or raw land, we?re ?speculating?, but when we buy growth stocks or growth stock mutual funds, we?re ?investing?? Where?s the dividing line? Is there a dividing line, or is it all marketing spin?
In recent decades, investing in the stock market has become common even and especially among the middle class. We?re routinely guided to ?invest? money in stocks for future gain, and inundated with newspaper, magazine, TV and internet ads promising us double digit returns for placing money in this or that mutual fund?albeit with the caveat ?past performance is no guarantee of future performance?. But exactly how do we process all of that? Do we process it at all?
In Investing Basics: What Is an Investment? Paul Williams at Provident Planning introduces the concept of familiarity blindness, a state in which ?most of the basic questions don?t occur to (us) any more?. This is a valid observation of the human tendancy to avoid challenging assumptions once they?re fixed in our minds. Though we give lip service to the volatility of the stock market, do we also turn a blind eye to it’s clear speculative nature?
What is investing, and what is speculating?
Paul describes speculating as, ??often a zero-sum game, where someone else has to lose so you can win (and where) No wealth is created?it simply changes hands.? I?m on board with that.
Dictionary.com defines the two terms as follows:
Investing: to put (money) to use, by purchase or expenditure, in something offering potential profitable returns, as interest, income, or appreciation in value.
Speculating: to engage in any business transaction involving considerable risk or the chance of large gains, esp. to buy and sell commodities, stocks, etc., in the expectation of a quick or very large profit.
The definition of speculating seems clear, but the description of investing is broad enough to be close to meaningless–I think what it describes is the popular connotation of investing more than anything else. Note the last part of that definition, “or appreciation in value”; isn’t that the very reason one would buy commodities or raw land? Why is that not considered investing as well?
The argument that commodities and land are speculations is typically based on the claim that they pay no interest or dividends. I fully agree. But wouldn’t growth stocks fall under the same category? Most pay no dividends, or even offer a promise of doing so in the foreseeable future, yet when we put money into them, we somehow believe we?re investing.
Let?s take one more shot at definitions. I was a finance major in college, and in a course called ?investment theory and analysis? I had a professor (who actively worked on Wall Street) who said that you?re investing when you buy an asset that gives you a revenue stream (interest or dividends); you?re speculating is when you buy an asset with no revenue stream in the hope that it will be worth more in the future. This is also known as the greater fool theory–buying an asset at a certain level in the hope of finding a greater fool who will come along and pay a still higher price.
The only reason anyone sinks money into non-dividend paying stocks is the ***hope*** that they will either a) pay dividends in the forseable future or, much more likely, b) rise substanitally in value. How is that different than what one might hope to do in buying commodities or raw land?
From a practical standpoint, I think my professor offered a bankable distinction. Put this way, should we be looking at growth stocks in a different way?
Two stock market crashes in 10 years should have us thinking
The purpose of this post isn’t to advocate for commodities and raw land being similarly classed as investments in the way we label growth stocks, but to emphasize that all asset classes that offer no immediate revenue streams are speculations by their very nature. Marketing spin aside, they should be called what they really are and handled accordingly.
Would you put money into growth stocks if a financial advisor (or marketing pitch) recommended that you put your money to work “speculating in growth stocks”? No, put that way, it just doesn’t sound quite as appealing, as certain, or even as responsible as if you were told to put your money to work ?investing in growth stocks?. One word changes everything.
If putting money into growth stocks is in fact speculating, how should that change our behavior?
- Make sure that most of your money is properly invested in income producing assets like CDs, Treasuries, bonds and dividend paying stocks.
- Have only a minority percentage in growth stocks (speculations). View them in the same way you would commodities. A famous investor (but not famous enough for me to remember his name) recommended ?investing down to the sleeping level?. Sound advice!
- Tune out the investment chatter from the media. Besting market averages requires outperforming the market consistently over decades and extremely few ever master that.
- Structure your investments to be relatively worry-free. Unless you?re independently wealthy, keep your mind free and your time clear to concentrate on your occupation where the real money will be made.
- Paying off debt is a true investment. Not only does it offer a guaranteed return from the interest not paid, but it also improves your cash flow and opens up options in life that you can?t have as a debt serf. This needs to be a priority.
- Adjust your retirement savings projections to fit reality. In Will A Million Dollars be Enough to Retire On? we covered the absurdity of perfect world retirement portfolio projections. Workable retirement planning should incorporate a combination of good health, a debt free position, the ability to live beneath your means, and work you can do for the rest of your life.
I believe most people should have at least some of their money in growth stocks. The potential payoff is real, but just as real is the risk that?s being taken on in the process. Make sure you understand that risk fully, and have taken steps to minimize it?s impact first.
Based on the way you have your ?investments? configured, are you investing, or are you speculating?