Investing & Speculating

An investment, as far as we are concerned, is something where a complete loss is not possible.

For example, if you buy the S&P500 stock market index you are a part owner in 500+ of the biggest, most successful US companies. If one goes bust another replaces it – the winners rise, the losers fall. In this way the S&P500 is self-cleansing, you need do nothing, buy it, sit and wait. Throughout you accumulate dividends that are reinvested to compound your returns or paid out as income

With an investment, you buy and own something tangible that should always retain some value. The degree to which that value fluctuates is volatility. Volatility can become risk if changes in value affect your financial life adversely. In that way any investment can start to become a speculation.

Speculating, as we understand it, is anything that can result in a complete loss.

For example, rather than own the S&P500 you might have decided to become an owner of Enron. Because individual shares can expire worthless, you would have been speculating. By owning a single company, or a few similar companies, you are speculating that they will do better than all 500+ grouped together. You will be proved either right or wrong, but you cannot know in advance which.

Various assets, by their nature, are always speculative including livestock, wine, cars, art etc. or where a large amount of debt is involved, or where there is a lack of liquidity, transparency or knowledge.

There is, of course, a sliding scale between these two poles. In the world of the mass affluent only investing makes sense – a complete loss can not be borne.

For high achieving high earners some speculation, with the aim of achieving outsized returns, can be desirable.

In our opinion you should invest sensibly to then allow yourself to speculate as wildly as you wish or, do both in tandem. Speculating on its own is not a sound strategy because complete capital loss and financial ruin is not tenable.

There are people that have become immensely wealthy through speculation alone. But there are many, many more who tried and failed. What we see are the survivors, their stories are told and regaled. Those that perished are quietly forgotten and ignored in the stats.

Charlie Munger is 98 and still investing. With a net wealth around c$2.7bn he has done well for himself and is worth listening to. His view is: “It’s very common to be utterly brilliant and still think you’re way smarter than you actually are”.

Howard Marks once talked about an investor whose annual results were never ranked in the top quartile. However, over a 14-year period he was in the top 4% of all investors. If he keeps those mediocre returns up for another 10 years, he may be in the top 1% of his peers – one of the greatest of his generation despite being unmentionable in any given year.

Speculating can sit alongside investing, but speculating alone is not wise, it is difficult to get back from total wipe-out. It is fair to say that enough, different speculative assets, when grouped together take on the overall look of investing, albeit with heightened levels of volatility and reduced levels of liquidity. Several speculations grouped together could therefore be deemed a “high risk” investment, but only if those speculations are quite diverse.

Our suggested approach is to invest first, leave it alone to compound, start to build a solid base and protect your family in so doing. Then add some speculation if you wish. The chance of outsized returns is exciting and attractive, and the outsized losses are more easily accepted knowing you are building your family’s wealth on solid foundations.


Posted on

March 16, 2022