Benjamin Graham and Charley Ellis once had a conversation about the dangers of speculation that was described by Robert Hasgstrom in his book The Last Liberal Art:
“The problem with our industry, Graham insisted, is not speculation per se; speculation has always been part of the market and always will be. Our failure as professionals, he went on, is our continuing inability to distinguish between investment and speculation. If the professionals can’t make that distinction, how can individual investors? The greatest danger investors face, Graham warned, is acquiring speculative habits without realizing they have done so. Then they end up with a speculator’s return — not a wise move for someone’s life savings.”
The market has continued its recovery from the March 23rd lows in the S&P 500. There have been some concerning developments we have seen in the data and market psychology lately. Investors have gone from complete fear of a depression to anecdotes of wild speculation in the stock market. Free trading and easy online access are generally good things, you could also argue it has just created less friction for investors to speculate on stocks rather than invest. There are several explanations for this, free trading, the quarantines, government stimulus money, and a lack of sports betting moving those speculators into the stock market.
The Nifty 50 stocks were a group of stocks in the late 1960’s that traded at high valuations and were growing exponentially. These were great companies, and many of them are still great companies today such as McDonalds, Coca-Cola, and Proctor & Gamble. A few of those companies didn’t have such a great future and have gone away with Sears being one of them. The future of those companies looked so good it seemed like all you needed to do was buy them and hold them forever. This mentality bid up their valuations to such extremes, that their share price was subsequently cut in half and for some you had to wait a decade for them to get back to even. The price you pay for a stock matters over time.
There was a report highlighted by Smeade Capital Management about the current environment:
“This element of speculative risk was underlined by an article in The New York Times on July 8, 2020, Robinhood Has Lured Young Traders, Sometimes With Devastating Results. The author, Nathaniel Popper, writes about Richard Dobatse, a husband and father, who signed up for Robinhood through credit card advances. As he repeatedly lost money, Mr. Dobatse took out two $30,000 Home Equity Line of Credit (HELOC) to get more money involved with the trading platform with more speculative stocks and options, hoping to pay off his debts. His account value shot above $1 million in value, but as of the article, his balance was $6,956.”
Ben Carlson of a Wealth of Common Sense also highlighted several studies on these dangers:
Speculation can and will pay off for some tiny subset of the population through a combination of luck and good timing but it never lasts. And since luck runs out eventually the average results for speculators are awful.
In a study of retail day traders in Taiwan from 1992-2006, researchers discovered more than three-quarters of all day-traders quit within two years, with unsurprisingly disastrous results. The aggregate performance of all traders over the entire 15 year period was negative. Surprisingly, many of the worst traders stayed with it even after seeing periods of large losses.
It’s estimated that only 1% of day traders studied earn profits over time.
Another study that was updated just last month looked at day-traders in Brazil between 2013 and 2015. This group was using the equity futures market to make their bets. Researchers found 97% of all speculators who stuck with it for more than 300 days lost money. Around 1% of these traders earned more than the Brazilian minimum wage while just half of one percent earned more than the salary of a bank teller.
Their conclusion was fairly straightforward: “We show that it is virtually impossible for an individual to day trade for a living.”
Day-trading is an easy target but there are far more subtle forms of speculation investors can succumb to during times of market stress”
It is our job at La Ferla Group to help our clients stick to the disciplined investment policies we have in place. Whether it be the temptation to sell into a downturn or avoid the “Fear of missing out” when it seems like everyone else is making more money around you because they may be speculating. If you take the risk part out of the risk/reward equation, you will eventually end up with bad outcomes. The New York Times recently highlighted David Giroux portfolio manager of the T. Rowe Price Capital Appreciation Fund. This mutual fund is currently 25% of the Global Balanced Advisor. He talks about his investment philosophy and we thought it was important to share with our clients.
Rest assured, we at La Ferla Group are dedicated to the investment disciplines of the Global Balanced Advisor, Growth Equity Portfolio, and Diversified ETF Portfolio. We don’t care about the “noise” and what the bloviating pundits are spewing in the media. As Joe has said many times, if you want to make money investing, this is the formula: Discipline + Patience = Dollars.
Please stay safe and be happy.
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