Investing requires due diligence. One needs to do the research to come up with an investment thesis, expected return and the probability of achieving that return, and the factors that will cause you to exit your investment position. If you do not put the work into making an investment decision, you leaning more towards speculation.
Investing in an of itself is speculation. You are speculating that your investment research will result in an investment return. Unfortunately, for most people, they do not have an investment process to follow to make an investment decision. For this reason, most people are speculating, not investing.
According to the DALBAR study (feel free to look it up), which tries to understand the actions and performance of the average investor, the average investor significantly underperforms the S&P 500 index over time. Why? More often than not, it’s because the average investor does not consistently follow an investment process. Instead, the average investor becomes an emotional investor in volatile markets, chases investment fads that have already gained in value, or changes there investment strategy any time it doesn’t work out. The S&P 500 index has no emotions, does not change strategies, or chase fads. The S&P 500 is a collection of companies that strive to be profitable and grow over time. Simple. That’s why it works and outperforms the average investor.
I’ve worked with financial advisors since 2007, and I have seen them make the same mistakes: no real investment process, making emotional decisions, changing investment strategies when one isn’t “working”, swapping out of investments to make it look better on statements, etc. We’ll get into the insights into financial advisors in another lesson, but based on my experience, financial advisors fall into the same traps of the average investor and often fall into more speculation than actual investing.
So the next time you put money in an investment, ask yourself, your financial advisor, or your friend/family member that has “a great investment idea”…
- Is this investment decision based on an investment process?
- If yes, what is the investment thesis, expected return over what time period, what is your probability that the outcome will be achieved, and what are the factors that lead you to sell the investment.
- If no, then you are probably just speculating.
- Do I feel any emotional tie to this investment (are you being greedy or fearful)?
- If you are buying something just because it’s up a lot and you hear everyone talking about it and you “need to get in on the action”, you are probably just being an emotional investor.
- If you are selling something because it went down a lot and you can’t stand to see it keep going down, you are probably just being an emotional investor.
Summary
In summary, before you take your hard earned money and invest in something, please think through whether you are actually making a thoughtful investment, or are you just speculating with limited knowledge. Knowing this will help you in the long run.
If you do not have the time to do the investment work, then please allocate to an actively managed strategy that you are comfortable with their investment process. Yes, you will have to pay them, whether it’s an actively managed mutual fund, ETF, etc., or through a financial advisor.
We really hope this provides at least some high level insight into improving your odds of success and understanding the difference between investing and blinded speculation.