Learning to separate the concepts of speculation from disciplined investing


For some of us, it’s hard to give up on the idea that investing should be exciting. Picking stocks can be fun, and there’s nothing like getting your timing right and bragging about it later with friends. But it’s important to separate the concepts of speculation and investing.

For all the accumulated wisdom about asset allocation, risk diversification, and discipline, some people seem bound to see investing as an end in itself rather than a means to an end.

For these people, picking stocks is a hobby. They follow the gurus and soak up the financial media. Despite evidence to the contrary, they’re convinced they can build a consistently winning strategy by exploiting perceived mistakes in market prices.

Part of the reason is the human tendency toward overconfidence. For example, we all like to think of ourselves as above-average drivers, when that’s simply not possible. Likewise in investing, many of us believe we have powers of foresight not evident in the wider population.

A Duke University study of corporate executives published in 2010 found a dismal record of prediction among a group you might think would do well. However, of the 11,600 forecasts for the S&P 500 over nine years, the survey found executives’ estimates of future returns and actual outcomes were very different.* Research also suggests the tendency to trade a lot and make confident forecasts about stocks occurs more often in men.**

For many people, an investment approach that advocates working with the market, diversifying around risks related to an expected return, trading efficiently, exercising discipline, and watching fees and taxes, may seem safe, but not exciting.

For those who MUST take risks, it is possible to separate the investment nest egg from the play money. This would allow an investor who really wants to speculate, to do so only if long-term retirement money continues to be invested the safe, (boring) way. This way, the investor can buy some (expensive) entertainment and accumulate a few war stories to share, without compromising the asset allocation designed to protect his or her portfolio.

Disclaimer: Diversification and asset allocation strategies do not assure profit or protect against loss.

*Source: “Managerial Miscalibration,” Duke University (2010)

**Source: Quarterly Journal of Economics (2001)

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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