Monday, January 28, 2008

Saver, Investor or Speculator?

“A penny saved is a penny earned.”
- Ben Franklin

“A penny invested has a chance of beating inflation.”
- Kim Miller

Americans are great at speculating, mediocre at investing and terrible at saving. See which camp you fall into:

Savings are funds you put away for a future purchase or obligation or for an unforeseen event such as unemployment. You expect your savings to grow, albeit modestly without capital risk. You expect your savings to be available when you want with a minimum of trouble and without any dickering over its value (a dollar saved is always worth a dollar upon withdrawal). Savings are never investments. The prudent saver is patient and rarely disappointed, except on occasion when the yield offered across the street is ¼ point higher. The Saver has a plan and while he may be motivated to save out of fear, he is logical in his approach and is able to defer gratification. EVERYONE should be a saver.

Investments are funds you put into a venture in the hope of a future income or capital gains – i.e., that you will receive an income from the invested capital or be able to sell the investment for more than you paid in at the beginning (or both). You expect your investment to grow commensurate with the risk. Investments are never savings. The prudent investor is patient and is rarely disappointed – she knew what she was getting into at the beginning. The Investor has a plan and while she may be motivated to invest out of greed, she is logical in her approach and is able to defer gratification.

Speculations are funds you put into a venture with the certainty that it is going only in one direction: sharply up in value. Savings are frequently used for speculation (“I know this stock is going up – I’m going to put the household rainy day money in – it can’t miss!”). Speculators are never patient and are frequently – if not always – disappointed. They have unrealistic expectations going in. The Speculator doesn’t have a plan and is primarily motivated by greed – he is emotional in his approach and would have to look up “defer” and “gratification” in the dictionary. Think back to the late 1990’s when the US stock market did nothing but go up – do you recall reading a lot about “buyer’s regret” as the markets fell from their highs? Was that Investing or Speculating?

In my career I have met very few Investors but I’ve sure met a lot of Speculators. Most people think they are Investors, but they are really Speculators – “investing” on “hot tips” or buying “5 Star” mutual funds and then rending their garments when the reality doesn’t match their vision. Regret is such an ugly thing.

Investment entails the acceptance of risk – the dollar you put in today may not be worth a dollar upon withdrawal. If one expects an investment to appreciate by 10%, one has to accept the chance that it could decline by 10% (or more). The theoretical lowest value of a share of common stock is ZERO. The Speculator dismisses this absolute as “nay-saying” or “balloon piercing” or “boring”.

Let’s be clear: markets don’t care what we think! Stocks don’t care what we think! Mutual funds don’t care what we think! Bonds don’t care what we think! Invest all the emotion you like, it won’t make any difference. Think about your favorite sports team – if it mattered what you thought, wouldn’t they be champions every year?

The only way to win – with any consistency – is to have a plan. Use asset allocation to diversity your portfolio. Know the risks you are accepting and be comfortable. If you’re not comfortable, reduce the risk. Don’t accept more risk than you need to reach your goal. A good advisor will have you complete a Risk Tolerance Questionnaire before investing your money.

So which camp do you fall into?


No comments: