Investor or Speculator?

14 Aug 2014

By Chris Youseef

Are you an investor or a speculator?

I often meet with people who view themselves as 'investors' however, when I look closely into their financial affairs what I often find is that they are actually 'speculators'. So what is the difference?

Let's start by clarifying the basics; buying stocks, bonds or property doesn't, on its own make you an investor. What does? Consider the following:

Objective

This is what you are trying to achieve. If you don't have a destination, there is a good chance that you will get lost on the journey. Often people without an investment objective can get distracted by market "noise" and hence make bad financial decisions in times of uncertainty. This is mainly because they are making decisions based on their "emotions" and not on the "facts". What is your investment objective?

Methodology

This is the methodology that your investment decisions are based on. Why would you buy investment A in comparison to investment B? How do the investments you choose work together in a portfolio? Do they complement each other? How do you value the underlying investment, is it overpriced or underpriced and why? Some investors use earnings, expenses, assets and liabilities to make decisions, others may use the industry conditions and economic factors to make decisions. What is the risk that is associated with your underlying investments and how does that reflect your personal risk tolerance? Your investment strategy should also take into account the costs and taxes involved in buying/holding/selling the investments and what affect this has on your overall strategy. What is your investment methodology?

Time horizon

How long will you hold the investments? When will you buy and when will you sell? It is important that you know this as it will prevent you from being reactive and making decisions influenced by emotions and short-term market conditions. Evidence suggests that this could erode your returns as shown in the graph below.

Cost of timing the market graph 

Source: Morningstar

Not to mention people who have cash flow and liquidity requirements need to ensure that funds are accessible to them otherwise they may have to sell your investments when they are in the red (making a loss). Obviously this is not ideal. What is your investment time horizon?

Benchmark

It is important to measure your progress. How do the investment decisions you have made compare to your investment objectives and to other alternatives. A 10% return might be a good result in isolation. However if the benchmark has performed at 15% this equates to a poor result. It is important to understand 'why' your results differed from the benchmark and whether you need to make changes to your investments. What are your investment benchmarks?

There is a lot more to investing than just buying and selling. It is extremely important you have an investment strategy that is best suited to you, your objectives and your time horizon. Investment strategies are all different and will result in completely different outcomes. You may have had some luck in the past and picked a few winners however, this may not always be the case.

This reminds me of some great advice I received from my father when he taught me how to drive. He said that anyone can put their foot down on the accelerator however, this doesn't make them a good driver. He also said that if you have an accident in the early stages of driving you will be very hesitant moving forward. Investing is no different; anyone can take their money and put it in "the market" but this doesn't make them a good investor. I have met many people who have made poor decisions and unfortunately have lost a significant amount of money. Most of these people are now very hesitant to invest in anything due to their poor experience.

If you don't have an investment strategy or are unsure as to how your investment strategy compares to other alternatives, I encourage you to get a second opinion from a professional financial adviser. Remember not all investment strategies are created equal.

To learn more about Chris view his online profile.

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