Tuesday, June 1, 2010

Are we investors or speculators?

We have talked about different investment classes such as stocks, bonds, GICs and real estate. But what is really a big issue in people’s minds is risk. Stock are considered by some as more risky than real estate, while others see it completely opposite and consider real estate high risk. Some authors claim you would do better if you stick with GICs and that the rest is just designed to provide income for stock brokers, realtors, banks and fund managers.

Risk is an elusive concept and of course, I have my own ideas about risk. I suggest that risk as traditionally defined by academia or stock market analysts is not necessary the same as how you may perceive risk. So over the next while, I think we should talk about risks incurred by investors.

In the oil industry, risk is common and although we call investing in appreciation often speculative, putting money in the oil industry we do not seem to consider speculative. If we invest ‘gambling’ on the price increase of a particular stock, say Google, risky and speculative, we call putting money in BCE an investment although we count both on its dividend and appreciation. The long term investor considers trading in options, day trading and momentum investing speculative and that is meant in the derogatory sense. Yet, from time to time, I write covered call options to supplement my dividend income and I don’t consider that risky at all. Real Estate investors look down on those that invest in pre-built condominiums, but then what is investing in raw land?

When people talk about investing they seem to say that there is no uncertainty involved. You have a predictable positive cash flow or dividend stream. The question is then are dividends and positive cash flow streams constant and 100% certain? The answer is ‘No’! If vacancies rise, rents may decline and you may go from positive to negative cash flow; in recessions, dividends may along with falling earnings be cut. We buy stocks, because earnings increase over time (we hope) and at least keep up with inflation. Not only that, we expect dividends to increase, that is one of the main attractions for dividend investors is that not speculation? While real estate investors do hope their rents increase overtime.

Well, but then maybe we should only invest in GICs and money market funds. Oops, remember 2008, when some U.S. money market fund actually lost money? And what about those money market funds that paid 0.03% interest compared to 3 or 4% just a few years back and 13 to 14% in the early 1980s? What about investing in GICs of the Principal Group, which investors thought where ‘insured’ until the company when broke?

So, clearly, with all investments risk is involved and the difference between a ‘speculator’ and an ‘investor’ becomes increasingly fussy? It seems to me that the terms are fluid but overall, a speculator seems to take on ‘higher risk investments’ often hoping on above average asset appreciation.

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