Investing or Speculating

Good Morning Relaxing Retirement Member,

Are you an investor or a speculator? That is the question this week, and there’s tremendous danger from the wrong answer!

In this Retirement Coach Strategy of the Week, we’re going to move on to the 4th reason why I believe retirees earned 58% less than the S&P 500 stock market index each and every year over the last 20 years.

To refresh your memory, here’s what Dalbar, Inc.’s study revealed for the 20 year period ending in December, 2010:

  • The Average annual return of the S&P 500 Stock Market Index from 1991 – 2010 was 9.14% (including dividends reinvested)
  • However, the average annual return of the “average” equity mutual fund investor (not investment, but an investor, i.e. a person) over the same 20 year period was 3.83%
  • The Average annual return of the Barclays Aggregate Bond Index from 1991 – 2010 was 6.89%
  • However, the average annual return of the “average” bond mutual fund investor (not investment, but an investor, i.e. a person) over the same 20 year period was 1.01% (a difference of 85.3% per year).

What you can’t help but take away from those statistics is that, while it makes all the news, markets or bad investments are not our biggest problem.

I know I keep repeating that, but there’s a very important reason that I’d like you to ingrain in your mind. The big problem is investor behavior which is driven by their “strategy” or lack thereof.

Think about that for a moment. Something that we all can control is what our biggest problem is.

So, let’s jump into the 4th problematic investing behavior that we all can control:

Investing or Speculating?

Have you crossed the line from investing into “speculating”.

Well, what does that mean?

A speculator chases price trends.

An investor chases value.

And, what investors know that speculators never know is that price and value are inversely related.

So, for example, think back to 2002 when high tech internet stocks were going through the roof.

As their prices rose, the interest in them rose dramatically at the same time. People continued to pour more and more money into them. And, nobody was buying what was then referred to as “old economy stocks” like Berkshire Hathaway.

Speculators

Speculators always respond to price. And, this means on the way up and on the way down.

They believe that the risk of a particular investment goes down as the price goes up. So, as the price goes up, the risk appears “lower” to them.

Conversely, as the price of an investment drops, they believe the risk goes up thus leading them to sell it!

Let me repeat that because you definitely want to make a note of it.

Speculators always respond to price. And, this means on the way up and on the way down. They believe that the risk of a particular investment goes down as the price goes up. So, as the price goes up, the risk appears “lower” to them.

And, conversely, as the price of an investment drops, they believe the risk goes up thus leading them to sell it!

An investor, on the other hand, migrates toward an investment whose price has fallen because an investor knows that as price goes down, the value of the investment goes up.

Real Estate

Another example of this is real estate over the last 5 years. There was a good stretch there where anyone would pay any price for a condo in Boca Raton or Naples Florida because they believed that the price would double in 3 years!

And, as prices rose, the fury got greater and greater.

Was that investing? Or was it speculating?

Well, we all know that it was speculating. And, look what has now happened. You’re lucky if you can get out of one of those things for 50 cents on the dollar today! As I noted last week, I have a friend who bought a condo in Naples for $429,000 that he can’t sell today for $160,000!

The bottom line is that one of the gravest mistakes which led investors to earn 58% less each and every year over 20 years is speculating and making investment decisions based on chasing price movements instead of pursuing long term value and, thus, “investing”.

There’s a huge difference.

Whenever you’re considering any investment, stop and ask yourself if the reason you’re interested is its recent price growth? That will give you clue as to which side of the fence you’re on.

Committed To Your Relaxing Retirement,

Jack Phelps

The Retirement Coach

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