"How come my accounts were down last month?" Such was the question recently posed by a client. My response? "Because the market was down more than one percent. And we're invested in the market."
His follow-up comments provided a diagnosis. My client, an otherwise reasonable man, suffers from speculation syndrome. Believing that his investment returns should operate independently of the broader markets returns. Daily. Monthly. Annually.
An affliction suffered by sports betters, day traders, card players, bubble chasers and gamblers of every stripe, speculation syndrome prevents one from seeing the forest for the trees.
Such cases are symptomatic of today's immediate gratification society. Where rationality is riven by a lack of long-term vision. Where the media has romanticized the enigmatic hedge fund trader. Even as the hedge fund index has woefully trailed the S&P 500 the last half decade.
Speculation and investing? Like water and wine. Both have a place. Though wholly distinct.
Thoughtful, prudent investing leads to financial autonomy. But it is a long-term process. For no seed flowers overnight.
Speculation, though often confused with investing, remains a divisive topic. Investing's erratic, wayward brother. Who left home as a teenager. Only to return three years later with full body tattoos. And an eye patch.
Speculation lurks behind much of the contemporary financial and economic news. Foreign currency crises. Stock market bubbles. Crashes. Derivative explosions. Technological innovations. Busted family fortunes.
Investing represents the wind in your sails. Speculation? The hurricane that appears, ominously, on the radar. Both from the same ecological system. Birthed from disparate origins. Bringing antithetical consequences.
Some argue that speculation is a benign force. Essential to the functioning of any capitalist system. While others believe the speculator a parasitical figure. Driven by greed and fear. Creating and thriving upon financial chaos. A slave to his passions.
Adam Smith, in his The Wealth of Nations, referred to the sudden fortunes that are "sometimes made... by what is called the trade of speculation." Yet, Smith viewed the speculator not as a financial operator but as an entrepreneur. One who provides a viable purpose within the financial ecosystem. A corn merchant one year. A tea merchant the next. Entering into a trade when he divines an opportunity for abnormal returns.
John Maynard Keynes differentiated investing from speculating as "the activity of forecasting the prospective yield of assets over their whole life" versus "the activity of forecasting the psychology of the market."
Speculation, conventionally defined as an attempt to profit from changes in market price, is different from investing. For the speculator forgoes current income in hopes of a quick capital gain. Speculation appears active. While investing occurs more passively.
Austrian economist J.A. Schumpeter explained that "the difference between a speculator and an investor can be defined by the presence or absence of the intention to trade, that is, to realize profits from fluctuations in security prices."
The line separating the two terms? So thin that some observers have coined speculation as the name given to failed investments, while investment is the name given to successful speculations.
Wall Street wise man Fred Schwed declared that stating the difference between investment and speculation was "like explaining to the troubled adolescent that love and passion are two different things. He perceives that they are different, but they don't seem quite different enough to clear up his problem." Schwed concluded that the first objective of investment was the preservation of capital. While the first aim of speculation was the enhancement of fortune.
He concluded that, "Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming little."
Speculation has often been analogized to gambling. For a bad investment may be a speculation. And a poorly executed speculation can be described as a gamble. The psychologies of gambling and speculation? Nearly indistinguishable. Both dangerously addictive habits holding out fortune as the prize. Both often accompanied by delusional behavior. With success in both pursuits often scuttled by an inability to control emotions.
While speculation has come to mean many different things, the common thread being that it involves a financial postulation lacking a firm factual basis. Which is why many speculators have historically consulted with occult theorists, alchemists and astrologers in order to bolster their odds.
The primary difference between the two pursuits remains the financial uncertainty assumed. In other words, the acknowledged "risk" integrated into one's activities. I
If a gambler bets on a game, his creates risk. While the speculator who buys stock is involved in the transfer of existing risk. Though often at a much more aggressive pace than investing.
Speculation, generally considered much riskier than investment, lacks the "margin of safety" within most investments, said Ben Graham. An investor takes the time to consider the the potential returns and risks inherent to any long-term position. While a speculator may forgo such investigations, yet have a escape plan should things not go his way. The gambler may simply toss capital towards opportunity with little thought towards the merits, risks or escape routes.
One might conclude that speculation resides somewhere between investing and gambling. Though, given the human inability to detect financial risks, it's no less dangerous. Evolution enables us to run and hide from predators on the Serengeti Plains. Not to detect a derivative bubble forming on the balance sheets of global investment banks. Though both scenarios can kill you.
The history of gambling and speculation are rife with colorful characters, interesting episodes and wild tales. As opposed to the less interesting narrative following the history of investment. Yet, unlike the staid tale of investing, gambling and speculation have left a vapor trail of rag-tag failure, tragedy and destitution.
Charles Mackay, author of Extraordinary Popular Delusions and the Madness of Crowds, provided a compendium of some of the original speculative catastrophes. Tulip Mania. The Mississippi and South Sea Bubbles. In addition to their cultural equivalents. Such as national delusions. Witch hunts. And the crusades.
One need not return to the era of Dickens, however, to get a feel for the intrinsics of speculative mania. The last 15 years alone have seen two such fervors break the financial backs of countless participants. The first being the dot-com mania of the late nineties. The second being the real estate driven credit crisis of 2008. Both of which remind us of Mackay's wisdom, still resonating some 174 year later:
"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."
Speculation, we might then conclude, has often been a collective pursuit. Fueled not by forward-thinking analysis but by short-term avarice. As children emulate those around them, so do speculators find themselves aping the actions of peers. Usually with little heed to the variables required of any successful outcome. Nor are such behaviors lost on any ethnicity, nationality or socioeconomic class. The factory metal stamper bets on football. As does the upper-level executive. Both usually lose. But continue, regardless. Likewise, those buying dot-com stocks fifteen years ago sprung from every background and profession.
Nor are politicians immune. Who, Alfred Marshal wrote, have stimulated speculative manias for their own gain on numerous historical occasions.
Jesse Livermore, the great speculator of the early 20th century, began investing as a teenage boy. He turned six dollars into a 100-million dollar fortune. And then lost it all. Twice. As interesting a character as there is in the annals of speculative history, his biographies are still fodder for Wall Street traders and hedge fund managers today. Telling, when one learns that this Wall Street swashbuckler concluded his career with a bullet to the brain. Tired of being driven by the heat of his speculative fires.
While the neural pathways and synapses populated by passions for investing and speculation may overlap, the road diverges greatly thereafter. With the investor realizing that his fortunes will be hinged to a combination of market returns, risk-calibrated decisions and emotional management. And the speculator living and dying with every statement, decision and transaction.
Speculating and investing. Two separate activities. Different mindsets. With only one, statistically, leading to financial autonomy. Not to mention that most desired of treasures, peace of mind.