The following is a post by MPFJ staff writer, Kevin Mercadante, who is a freelance professional personal finance blogger for hire, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.
With the stock market being at record highs, now is an outstanding time to pose this question. Market tops bring out excesses. This includes investors who are looking for easy money profits. But that’s not investing – it’s gambling.
In truth, your objectives and strategies will define whether or not you are an investor or a gambler. Let’s review some of the parameters that will help you to understand which.
When Is It Investing?
Investing places value on many of the following strategies:
Investing in fundamentals. You’re looking for companies with a strong track record of increasing earnings, strong brand loyalty, and solid financials. If the fundamentals are strong, the day-to-day price fluctuations are less important. The long-term deck is stacked in your favor.
Understanding that price does matter. You recognize that just because a stock is a good investment of $30 a share, doesn’t mean that the same will be true when the stock is trading at $60. Stock value must be considered relative to fundamental value.
Respecting risk. You have a keen understanding that stocks can fall in value as easily as they can rise. For this reason, you are highly selective as to what you invest your money in. You will always do your best to be invested in stocks that have minimum downside risk.
Building a balanced portfolio. This is really the process of investing around risk throughout your entire portfolio. You work to make sure that your portfolio is balanced between growth and income, as well as between various market sectors. While this may limit growth in bull markets, it also minimizes risks in bear markets. You’re willing to maintain that balance because you’re in for the long haul.
Having a long-term view. You understand that stocks fluctuate in value. For that reason, you absolutely favor investments that are likely to perform well over years, and not just the next quarter or two.
Understanding a sector, or the general market. You recognize the value of investing in different sectors, but you also know that sectors can fall out of favor. For example, you understand that just because energy is critical to the economy, doesn’t mean that it’s always a good investment. You also recognize that while you can’t time the market, there are better times to be buying than others.
Having well-defined investment goals. You’re not just investing to make money, but rather to reach specific goals. This can include investing to pay off your mortgage, pay for your children’s college education, start a business, or to retire. The existence of investment goals forces you to create specific strategies that enable you to reach those goals with the highest level of predictability.
Minimizing trading. True investors don’t trade. They invest in companies for the long-term. They recognize that trading is highly speculative, and subjects you to paying very high transaction costs, which lowers your overall investment return.
When Is It Gambling?
Gambling is more opportunistic in nature, and often includes the following practices:
Betting on trends. If a stock or a sector is doing well at the moment, you load up your money there. In fact, you’re on a constant lookout for trends that can be exploited for fast profits.
Following the herd. This can include jumping into popular stocks or sectors, but it can also involve investing primarily in rising markets. You wait for bull market trends to be firmly established before getting in, then often follow the herd by selling only after crushing losses. The emphasis on following the herd often sees you buying and selling at the worst possible times.
Ignoring yield. Not that growths stocks are bad investments, but you may ignore dividend yield in favor of the prospect of bigger returns from price gains. But though dividend paying stocks may grow more slowly, they’re often better long-term investments because they maintain the practice of returning some of the profits to shareholders.
Ignoring fundamentals. If you’re investing in trends or following the herd, the underlying strength of the companies may not be critically important. But while the trend may produce impressive short-term gains, it’s the fundamentals that make for the best long-term plays.
Timing the market. The problem with market timing is that it’s impossible to call with any real accuracy. And even if you get it right from time to time, it’s totally impossible to do with any consistency. Timing also ignores the underlying strength of individual investments, as it emphasizes price swings more than anything else.
Buying stocks on tips. Though you may not know much about a company, you’ll buy the stock if you hear about it from a source you consider to be credible. Or at least you buy and hope that the source turns out to be credible.
Looking for the quick hit. This is probably the most defining characteristic of a gambler. While an investor will develop a long-term strategy to earn steadily compounding returns over years or decades, a committed gambler is always on the prowl for a quick profit.
Investing in what you don’t understand. A gambler may not be terribly interested in specifically what it is he’s putting his money into – the main consideration is the potential of the stock to produce a positive return, and in the shortest possible time frame.
It may be that the main difference between investors and gamblers is emotion. While the gambler thrives on the prospect of a quick profit – even if it doesn’t happen often – the investor is mostly looking to remove emotion from the investment process. She’s more interested in steady, if unspectacular returns over the very long-term, to keep her portfolio moving steadily forward.
Both the gambler and the investor see themselves as investors, but guess which one does better over the long-run? That message may once again assert itself with the market flying so high as it is. Gamblers tend to be the biggest victims when record markets reverse.
How about you all? Have you ever seriously analyzed if you’re an investor or a gambler? What did you discover?
Share your experiences by commenting below!
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