June 25, 2013
Are You an Investor or Are You a Speculator?
This is a question that many are quick to answer, but few understand better than famed economist and investor, Benjamin Graham. Mr. Graham’s career was a testament to his ability to navigate the hope, fear, and greed within the investment market that results in poor investment decisions. He articulated this best through the statement:
"The individual investor should act consistently as an investor and not as a speculator. This means that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money's worth for his purchase."
As the markets continue their forward trajectory through the first half of 2013, the distinction between investing and speculating has become more important than ever. We are in a unique environment today where many asset classes have erased the unrealized losses of the financial crisis and both equity and fixed income valuations are skewing toward the expensive. In this uncertain period, with the S&P 500 over 1,500 and the 10 yr. Treasury at 2.5%, what distinguishes an investor from a speculator?
The answer is the same as it has always been – an investor uses objective, quantifiable analysis to determine which assets can be purchased at an attractive price relative to their inherent risk profile. This has always been at the core of Hirtle Callaghan’s valuation based investment methodology. As investors, we must focus on those asset classes that are priced attractively and offer a substantial risk premium over the alternative.
An investor, in Mr. Graham’s mind, needs to get “more than his money’s worth” for every purchase he makes. We agree, which is why in today’s liquid markets, we choose to focus on those assets that reward an investor with a substantial risk premium over the alternative: international emerging markets equities, international developed equities, and commodities. We avoid those areas that have reached unattractive valuations – publicly traded REITS and small cap equities – yet continue to appreciate based solely on price momentum. This is the “greater fool theory” – purchasing assets at inflated prices or valuations based on momentum and the assumption that you will be able to sell it later to "a greater fool.” That is the realm of the speculator.
Increasingly, the investor must also look to the private and illiquid markets to identify those investments for which they will be rewarded with a substantial risk premium. Although the characteristics and structure of these investments may differ from those in the liquid markets,
The challenge for the investor is that the correct investment decision may not pay off in the short term and could take time to bear fruit. Compounding this issue is that speculators are often rewarded by short term momentum in an asset class. So what is the investor to do? Focus on the price he pays for an asset and the risk premium he achieves, knowing that he will be rewarded for his discipline far greater and longer than the speculator can ride the short term wave of momentum.
So, are you an investor or a speculator?
Patrick M. Decker, CFP®
Patrick is an Investment Officer with Hirtle Callaghan. Patrick works with clients in the Southeast Region. Prior to joining Hirtle Callaghan, Patrick worked in the brokerage department at Vanguard. He received his B.A. in Economics from Washington and Lee University in 2000 and is a Certified Financial Planner™ .