March 16, 2024
I recently finished the book The Intelligent Investor, by Benjamin Graham. Graham is considered the father of value investing and was Warren Buffet's mentor. He makes a distinction early on in his book between investing and speculating. Most speculators, he says, incorrectly believe they are investors. To invest, in Graham's words, is to put capital into something which, "upon thorough analysis promises safety of principle and an adequate return."
Graham notes that, "speculation is neither illegal, immoral, nor (for most people) fattening to the pocket book." He goes on to say:
There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are:
- speculating when you think you are investing;
- speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it, and;
- risking more money in speculation than you can afford to lose
The point here is that investing and speculating are two different activities, and the key difference between them is that investing promises safety of principal.
With that in mind, consider the angel investor. Most of their investments go to zero - so the assumption is that they risk 100% of their principal. They are actually speculators. While the title "angel speculator" doesn't hold the same level of distinction, note Graham's comment that there is nothing immoral about speculation. Case in point: many of the biggest tech companies today would not exist at all had it not been for the speculative bets of angels in their early days. The same could be said of the railroad, steel, and oil industries.
The problem is that speculation is an alluring game. Throughout The Intelligent Investor, Graham occasionally shares pieces of advice about how to select an investment and then immediately discounts the value of his own advice, saying that in practice its value is simply to give the investor something to do. His point is that an individual may be prone to speculation if they don't have anything to do. Put another way, unintelligent speculation is often a result of boredom or a bias towards action.
It's not hard to understand why this is the case. It's easy to look at a stock's price-chart and say to yourself, "If I had bought then and sold now I would have made an xxxx% return in only a few weeks/months/years". Hindsight makes the process look easy. While some people can consistently yield positive returns through speculation, these individuals are akin to professional athletes. If, for example, you understand finance better than 95% of people, you may think you could be a successful speculator. But if you were better than only 95% of people at golf, you would be wrong to believe you have (currently) what it takes to be a professional golfer. You should be better than at least 99.99% of people.
At the end of the day, speculation decreases wealth for most people engaged in it. Don't get caught off-guard speculating when you think you're just investing.