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Tuesday, July 14, 2009

Are you an investor or a speculator?

"Avoiding where others go wrong is an important step in achieving investment success. In fact, it almost ensures it."
- Seth Klarman, 'Margin of Safety'

If you are like me, your first foray into the stock market was probably buying 100 shares of a 'cheap' stock on a friend's tip. That's speculation. No wonder I ended up losing money!

The characteristics of a speculator and investor are almost exact opposites of each other. How can you tell if you are one or the other? Here are some indications:-

1. On a whim, you go to the railway station, buy a platform ticket and jump on to the first train that is departing, without having any idea where it is going. Isn't it exciting? You are a speculator.

You plan ahead and make your seat reservation a month in advance; go to the railway station a half hour before the scheduled departure; board the train, find your reserved seat and settle down for the journey, knowing how long it will take to reach your destination. You are an investor.

2. It is a Sunday. Some friends visit unannounced at 7 pm. You serve them tea and refreshments. At 8 pm you suggest going to the movies. All of you agree and go to the nearest multiplex, but find that all shows are 'house full'. So you go to the food court and have 'idlis' or burgers instead. You are a speculator.

You call up a few friends mid-week and ask them if they would like to catch a movie next Sunday. They agree. You go to the nearest multiplex and buy tickets in advance for Sunday's show. On Sunday, your friends arrive. You serve them tea and refreshments. Then all of you go and watch the movie. Afterwards, you grab 'idlis' or burgers at the food court. You are an investor.

3. You have recently graduated from college and are looking for a job. You buy some newspapers and go through the 'Jobs' columns. You circle the addresses of several companies, and send across your resumes. The process is repeated for several weeks without much success. You are a speculator.

You are still in college. During the summer vacation, you work as an apprentice for free in a company owned by a friend of your older brother. Next summer, you repeat the process. After graduation, you get a job offer from your brother's friend, who has not only come to know and trust you, but is impressed with your diligence and forethought. You are an investor.

4. You hear that a new highway is going to be built to bypass the town where you live. The proposed highway is supposed to pass through some inhabited villages. You visit the villages and buy up a few parcels of land, hoping to make a killing when the land acquisition for the project starts. But the villagers have political clout and block the land acquisition. After a few years, the highway is built bypassing the villages where you bought land. You sell at a loss. You are a speculator.

You wait for the land acquisition process to be completed and the highway construction to begin. Then you buy a plot of land near the highway, and build a convenience store-cum-motel. You are an investor.

5. You find out that Gruh Finance is a subsidiary of HDFC. You feel HDFC is too expensive and buy shares of Gruh Finance instead. But because of its regional bias and smaller size, the company never becomes the 'next HDFC'. After holding for some time, you sell the shares at a decent profit. You are a speculator.

You find out that HDFC is the company most respected by the FIIs because of its conservative and sound management. You wait for a price dip and buy a small quantity. You remain patient, and keep buying small quantities on every substantial dip and just keep holding. You are an investor.

I could go on, but you get the idea. Whims and tips and gut-feel may work very well in a bull market. But in a sideways trend or a bear market, the huge gains through speculation get wiped out fast by huge losses.

There are no short cuts to investment success. Diligence, discipline and the ability to analyse company fundamentals require effort and patience. It is not rocket science and can be learned. Why not start today? Why depend on others? There are no better way to ensure success in building wealth through stock market investments, than taking charge of your own investment decisions.

You neither have the time nor the inclination to do the hard work? Still want to benefit from the stock market? Buy a couple of index funds and a couple of balanced funds. Your long term returns won't be insignificant.

Related Posts

Should you invest in Balanced Funds?
Two Index Funds that track the Nifty 50
Your portfolio of stocks and mutual funds - why you shouldn't diversify


Anonymous said...

Thanks for an excellent article.By judging myself on 5 criteria prescribed by you , I turned out to be an investor.
Thanks again
With regds,

SG Money Mind said...

Thanks for the article.

Fine, just let me know what should I buy next.

That's the realty.


Subhankar said...

Hi Sujoy and SGMM

Appreciate your comments.

It is quite possible for the same person to be an investor AND a speculator. But equal success in both endeavours are rare.