A Rose by Any Other Name…

by Christopher Music on August 16, 2016 No comments
How the Redefinition of Financial Terms Creates Losses for Investors In William Shakespeare’s play Romeo and Juliet, Juliet states "What's in a name? That which we call a rose by any other name would smell as sweet,” wherein Juliet argues that only what things actually are matter and their names do not. In the world of investments, the terminology has subtly changed over the last 50 years by financial media to redefine certain concepts so they are more palatable to the mass affluent.  This has unfortunately created confusion in the public as to what they think they are doing in the investment markets as opposed to what they are actually doing. Let me explain. There are three main concepts that have been redefined over the years: Investment:  In Graham and Dodd’s book, Security Analysis (1934), it states "An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."  This means that investment is defined as the safety of principal (what you invested) as a first and foremost consideration, then achieving an adequate return with that principal as a secondary concern.  This is the boring kind of investing such as bonds, cash, fixed annuity contracts, primary home equity and cash value life insurance. Speculation: Per Graham and Dodd, anything not meeting the safety of principal test is speculation.  In other words, speculation is the willingness to give up principal in the anticipation that one may achieve a greater return than with investment grade assets.  This is summed up in equities, high yield bonds, real estate, small business ownership, commodities and other derivative investments. Gambling:  A good definition is presented by the Columbia Encyclopedia, stating “betting of money or valuables on, and often participation in, games of chance (some involving degrees of skill).”  The markets have become more of a gambling casino than an investment forum due to the methods by which retail and institutional investors alike approach the activity.  Just as there is skill in how one plays blackjack, there is skill in the manner one purchases and sells his stocks, but it still gambling just the same. The signs of gambling include:
  1. market timing, the attempt to gain better returns than the market by buying and selling assets based on short term changes in prices;
  2. stock picking, the attempt to outperform the market by picking outperforming stocks;
  3. trading stocks on margin-- borrowing money you don’t have in order to buy and sell stocks for hoped-for profit.
  4. Spending time doing “day trading”--trading stocks on the internet-- rather than working or spending time with family.
  5. Putting money in previously well-performing investments in the belief that the outperformance will continue, otherwise known as “chasing returns.”
  6. Having mood swings, from euphoria to despair, as gains and losses are experienced.
The word “investing” and “investor” is used in advertisements by brokerage firms on television to portray that stock trading is “investing” for “investors;” have you ever even heard the words “speculating” for “speculators?” It IS actually speculation or gambling, depending on the degree the signs of gambling are present. The truth is, one is investing when he owns assets that protect the principal first and make returns second, like a conservative bond fund.  If one owns a stock index mutual fund (one that has long-term positions with very low trading activity), he is speculating, pure and simple.  If one owns an actively traded stock mutual fund (one that trades continually), he is speculating/gambling. The last market downturn should have been a blaring siren to you based on your experience.  If you lost money, you were speculating or gambling.  The severity tells you which one it was. It’s just very important that we understand the risk we are taking when we place our money into different investment options.  Too many people don’t want to be told that they are “speculating” or “gambling “with their money—that’s really scary!  We like the word “investing” because that gives us the idea that we are more sophisticated and knowledgeable about such things. So the next time you hear these words you now know what they mean.  Pay attention to what the advertisements from financial industry are really telling you. Take the tip from Juliet.  She was a wise woman.