Investment Versus Speculation
What is an Investment?
According to the author,"An investment operation is one in which, upon thorough analysis, promises safety of principal and an adequate return".
Throughout the 1900s and even before that, stocks were only considered for speculative purposes. Only bonds were considered for investments.
During this time common stocks were considered to be “too risky”, and over 90% of the people were opposed to buying them. Also, the majority of the losses for an exchange came from common stocks.
Let us look into the basic differences between Investment and Speculation:
One of the important things the author talks about is to keep investment and speculation totally separate. If we research about a company, read its financials, then that particular trade decision should be considered an investment activity. Speculation should be avoided 99% of the time, but a 1% speculation is necessary which can benefit an investor. We should limit speculative activities to a maximum of 10% of investment funds.
Intelligent speculation can be achieved if we avoid three things:
- We must thoroughly analyse a company’s business model and its financials before buying its stock.
- Speculate only if you have necessary skills and expertise for it.
- Never speculate by taking loans.
Graham also points out that buying “fresh issues” or IPOs also doesn’t really help an investor in achieving high returns by generating quick profits.
The author points out an example in which he tries to explain how hard it is to speculate:
Between Dec 1960 and Dec 1970, Dow Jones Industrial Average (DJIA) went from 619 to 839, or 36%. But in the same paying period, the S & P 500 index went from 58.11 to 92.15, or 58%. S & P proved to be a better buy, but it was difficult to predict that a stock index consisting of 500 stocks would do better than a Dow Jones Index.
A successful speculator should always stay with the market’s latest trends, the trends work sometimes and start disappearing as they become popular.
The author then briefly discusses the outcome of a defensive and an aggressive investor, which they should expect.
Jason Zweig, mentions that Intelligent investing involves:
- Analysis of the fundamentals like balance sheet, Profit and Loss account, Company ratios etc.
- A calculated plan to prevent a severe loss
- A pursuit of a realistic return in the future
