Investing vs. Speculating

I’ve been working, and saving money, for more than thirty years now.  All this time I considered myself an investor, in that I didn’t necessarily try to gamble with my money, (other than a onetime ill-fated adventure into options trading), but rather would buy stocks, and stock funds.

So imagine my disappointment when I realized that, based on the perspective of one of the most famous investors of all time, I was more of a speculator than investor.

Why is this?  Well, simply because I would measure my wealth in the value of my holdings, rather than the income stream they produce.

I should have known better.  After all, years ago I had read the book, “Rich Dad Poor Dad“, and agreed with its general philosophy.  However, through the years Mr. Kiyosaki’s message had been diluted with the howls and bellows of “financial experts”, whose buy/sell NOW advice filled my head with all sorts of nonsense.

And so it was that during the Great Recession of 2008, I cut my 401(k) plan contributions to the bone, and prepared to sell most of my stock holdings for a loss.  Fortunately my innate laziness and procrastination served me well in this instance, for before I could get around to selling much the stock market had recovered, and begun its current climb.

Now if I had been wiser, I would have been buying stocks like crazy during 2008, 2009, and 2010, instead of looking anxiously at the value of my stock holdings.  Why?  Because rather than buy for the appraised value of an asset, hoping it would appreciate, (speculating), I should have been buying for the cash flow an asset was likely to generate, (investing).

Besides being the message of “Rich Dad Poor Dad“, this is the approach of none other than the Sage of Omaha, Warren Buffett.  But rather than attempt to paraphrase his thoughts, how about if I just let Warren speak for himself?

Here are some extracts from the 2013 letter to the shareholders of Berkshire Hathaway Inc., under the section, ” Some Thoughts About Investing”:

” Focus on the future productivity of the asset you are considering.”

” If you instead focus on the prospective price change of a contemplated purchase, you are speculating.”

There you go: advice from a rich man that is direct and to the point.  As for financial experts, market watchers/timers, and other money managing “professionals”, he adds, ” Forming macro opinions or listening to the macro or market predictions of others is a waste of time.  Indeed, it is dangerous because it may blur your vision of the facts that are truly important.”

Mr. Buffett states that the path to true wealth is to find a good income producing asset, then to HOLD ON TO IT.  He gives an allegorical example of someone who owns an income producing farm, whose next door neighbor, who also owns an income producing farm, is a bit of a madman.  Every day the neighbor runs out and shouts a random price he will either pay to buy farmland, or sell his.  These prices fluctuate wildly, subject to the mood and whim of the neighbor.

Wouldn’t it make sense to an investor to buy farmland when the madman is selling it at ludicrously low prices, and sell it when it is extremely overvalued?  Yet applying this allegory to the stock market, (which it is supposed to represent), how many of us overreact and sell our stocks when the market is in free fall, yet at the same time rush to join the stampede of stock buyers when the market is reaching new highs?

If we would instead value an asset based on its potential income versus its current price, we would think much differently about stocks, (and real estate, and any other investment), and realize that the ideal time to buy an asset is when everyone else is selling.

Easier said than done, I must admit, and it is all too easy to get swept along in the madness of the crowd, but if we want to have exceptional results, we have to behave against the norm.

Originally published by us on FullofKnowledge.