Thursday, May 5, 2011

The trend is not your friend

Sorry for the delay!  I am feeling a bit better and, I believe, of competent mind, and so without further adieu...

The trend is not, and never will be your friend.

Many investors that are just starting out confuse speculation with investing.  This is an understandable happenstance because so many professional institutional money managers themselves do not understand the subtle difference.  Most of these money managers are, in fact, forced by their bylaws to invest in the worst possible manner.  For example, many pension funds are disallowed from investing in any companies that are not listed in the S&P index.  This means that when companies are unlisted, these pension funds are forced to sell these companies at the worst possible time.  Consequently, these funds are chained by their own laws to buy only companies that share the same certain characteristics, and these companies they are herded into.

When professionals like these follow market trends, why shouldn't you?

Attempting to distinguish the difference between speculation and investing is a very difficult thing.  One man's speculation is another man's investment.  And, truthfully, when we invest in anything, we speculate partially about the investment's future.  I will lay out, for me, what this difference is.  When we speculate, we spend all of our time thinking the future will be as we see it.  When we invest, we attempt to deliver ourselves a return based on the facts we have today.

Why so many professional money managers are speculators and not investors is because speculation is, in fact, a much more interesting endeavor than investing.  (To some.)  And truly, who is the life of the party?  The guy who claims he can predict the movement of oil prices with his gut feeling, or the guy who talks about a public utility that will give him a 5.50% dividend yield?  And yet, I am here to tell you that the latter, more boring guy, is way more likely to live on a less shaky financial foundation than the first.  And logically, I think you can all see the benefit of obtaining investments over speculations.  An investment is a piece of property which you rent out to tenants.  A speculation is a condo you buy in Florida with the intent to sell in 6 months.  Neither is guaranteed to succeed, but one has a firmer footing.

So why do so many people still follow the trend instead of fight against it?  And why do so many people continue to speculate even though it can be catastrophic for their financial future?

I think there are elements to human nature that push us towards these behaviors.  Firstly, we put a lot of faith in and weight on the opinions of our friends and others we consider "authority figures."  We go to Yahoo! Finance and we see the two clowns from Tech Ticker (sorry, cheap pot shot, I know) parade a guest in front of us with a very strong opinion about where the market is going.  We watch CNBC and hear a loud-mouthed, belligerent but nicely dressed man talk about how the price of gold will go up forever.  The more frequently we hear these opinions, the more likely our brains are to accept them.  Because what we hear and see is speculation, speculation is what we do.  Monkey see monkey do!

But it is not just our human nature that spoils us.  If these money managers were not speculating and, more importantly, if these financial journalists were not spending so much time talking about speculating, we may ourselves steer clear of speculation.  If it is our mimicking of them that leads us astray, we should wonder what it is that leads them to present speculation as investment and lead us astray in the first place.

The simple answer is: entertainment.  Like the man at the party who wows everyone with stories of his oil trading, the people who present the financial news are no fools.  They are not in the business of properly educating you on how to get richer through savvy investment, never forget this.  You are not their clients!  Their advertisers are their clients, and their advertisers pay well for your attention.  If someone can come on CNBC and espouse the virtues of currency trading, during the commercial break you may be surprised to see a currency trading company enticing you with a free trading account.  When you go to Yahoo! Finance, you will see ample ads to click on right next to stories with shocking headlines designed to catch your attention.  I saw the other day a prediction that Apple would be a $3 trillion market cap soon.  Is it likely that the person who claims this actually believes it, or is it more likely that they are trying to get your attention and get their name well known?  Will they apologize later on when their speculation falls flat?

The point is, dear readers, is that speculation and gambling will always enrapture the human mind.  There is something that we love about risk, about thinking we can predict the future, about believing we can grasp at what the market will do and where it will trend next.  And yet, I tell you now, that speculation has more in common with roulette than it does with investing.

Ask yourself, when looking at a new investment, whether it really is an investment, or if you are speculating.  If you are on the fence yourself, feel free to comment and let me know what you are considering putting money towards!  Together we can arrive at a pretty good conclusion about what is an investment and what isn't.  From what I have learned as I have invested over the past years, is that speculators always crash and burn.  They may succeed spectacularly for a little while, but their losses are always substantial later on.  Even George Soros, who many mistake for a speculator, made most of his money in his core portfolio of value stocks.  Despite being famous for crashing the bank of England by shorting the pound, Soros has actually only broken even (that is, he hasn't made a dime) currency trading because of losses elsewhere.  He divulges this himself in his book The Alchemy of Finance, a good (if wordy) read that I recommend.

And, regardless, a good value investor never speculates.  He knows that the stock market is not a casino for him to play in, but a place for him to acquire businesses.  He is not there to play the casino, he is there to buy the casino.

See you next week!

1 comment:

  1. I have always believed in going against the crowd when it comes to investing. But also in other areas of my life. Their are far to many yes men in the world and far to few no men.