The Fallacy of Investing

Anyone that has money in the financial markets, whether directly through stocks and bonds or some other instrument, or indirectly through mutual funds and such, like to think of themselves as “investors”. Unfortunately, the vast majority of financial market participants, both laypersons and professionals alike, are not investors, but rather speculators, traders, and gamblers.

On the surface, investing, speculating, trading, and gambling are all the same. They have a common goal of profiting from information asymmetry. On each side of a transaction, one person thinks because of their superior information, or superior skill (just another form of information), or just plain luck (still another form of information), that they will be able to profit. At this level, the only difference between these four activities is the time period over which the profit expectation is spread.

Gambling tends to be very short-term, say the time it takes to roll dice or for horses to run a quarter mile. Trading is a little longer-term, such as seeking to profit on the price movement of a financial instrument over a day or week or maybe a few months. Speculating extends the time frame out a bit, maybe up to a year or two, perhaps to take advantage of currency swings. Investing captures the longest time horizons, preferably covering many years as a business builds its brand and enters new markets and such. But time is superficial. The more important differentiator is motive, or purpose.

The unfortunate reality of the financial markets is that the average “investor” doesn’t care about their “investments”. They don’t care about cash flow or discount rates or business fundamentals or value creation. They don’t care about the underlying asset (a business, physical asset, etc.) represented by the security in which they are dealing. They only care that someone will come along at some point and take them out of their position at a higher price than they paid, justified or not. This is not investing. This is speculating, trading, or gambling.

Investing is the act of committing resources to some effort in the hopes of creating value. Investing is what founders of businesses do when they start a new venture. Investing is what charitable organizations do when they raise and spend money for a good cause. Investing is what governments do when they fund infrastructure projects. Investing in our children is what we do by educating them.

Investing is not throwing money into the stock-of-the-day and hoping to profit next week because you think the latest political scandal will influence the price of the stock in your favor. Investing is not jumping into the market because your neighbor told you they made a huge profit on a stock tip. Investing is not managing a mutual fund to hit quarterly goals or to beat an index in an effort to boost management fees. These are speculative endeavors at best.

This isn’t to say that speculating, trading, and gambling don’t play their part in the financial markets. Certainly, they drive the majority of financial volatility and have been responsible for every bubble and bust since the beginning of recorded history. They provide thousands of jobs to finance professionals that hope to profit by out-thinking each other. They give individual investors a way to express their inherent tendencies toward greed and fear. And that’s all well and good, but it isn’t investing.