Ever since Joseph de la Vega wrote Confusion of Confusions in 1688, many of the world's leading investment thinkers have struggled to articulate the difference between "investing" and "speculating." Does a focus on "safety of principal and a satisfactory return" define investing, as Graham and Dodd contended in Security Analysis? Is speculation best understood as an effort to "forecast the psychology of the market," as John Maynard Keynes argued in The General Theory? Or perhaps the distinction comes down to long-term ownership of assets versus short-term trading — or the use of leverage and a focus on price action?
The answer matters: As Legg Mason Investment Counsel's Robert Hagstrom, CFA, pointed out in a recent blog post on the subject, a lack of clarity has created a new class of "investulators," individuals (and institutions, too, for that matter) who "wander aimlessly back and forth between the worlds of investing and speculation," often to their own detriment.
To help empower investors to make better decisions, a key aim of the Future of Finance project at CFA Institute, we've assembled a panel of leading investment practitioners to discuss the issue in our inaugural online forum, moderated by Jason Voss, CFA. Our distinguished panelists include former Ewing Marion Kauffman Foundation chief investment officer Harold Bradley; investment consultant and blogger Tom Brakke, CFA; Marret Private Wealth President Margaret Franklin, CFA, a former chair of the Board of Governors of CFA Institute; and Legg Mason Investment Counsel chief investment strategist Robert Hagstrom, CFA.
The discussion will run from 15–19 July 2013. If you'd like to share your perspective or pose a question for our panelists, scroll to the bottom of this post and leave us a comment. We'll do our best to incorporate your thoughts into the discussion.
The Panel
Harold S. Bradley (@HSBtheThird)
Harold S. Bradley recently retired after more than five years as chief investment officer for the Ewing Marion Kauffman Foundation, where he was responsible for investing the $1.8 billion globally diversified, multi–asset class portfolio. While at Kauffman, Bradley and his colleagues published three noteworthy papers. He coauthored "Choking the Recovery" (2010) with Robert Litan. The paper discussed modern trading and market making systems, high frequency trading, likely causes of the Flash Crash, and possible systemic risk issues raised by the trading and settlement of ETFs. A subsequent paper called "Canaries in the Coal Mine" (2011) examined the rise in settlement “fails” for ETFs and the possible risks to investors in turbulent markets. Bradley and colleagues published a paper called "We Have Met the Enemy . . . and He Is Us" (2012) that analyzed available data on the long-term performance of venture capital funds and raised questions about current institutional investment practices. Bradley worked for almost 20 years as an equity trader, portfolio manager, and group CIO for American Century Mutual Funds.
Tom Brakke, CFA (@researchpuzzler)
Tom Brakke began his investment career with IDS Financial Services (now Ameriprise), and during his fifteen years there was an analyst, portfolio manager, director of research, creator of new investment products and systems, and founder of the hedge fund unit. Subsequent to that, he was the professional advisor to the Carlson Funds Enterprise of the MBA program of the University of Minnesota and served as a consultant for the independent research portion of the Global Research Analyst Settlement. Brakke provides consulting services to investment organizations and institutional investors, specializing in decision-making processes and the effective communication of investment ideas. He also writes extensively about the industry, on his own websites and for other publications, and is one of “The Experts” for the Wall Street Journal forum on wealth management.
Margaret Franklin, CFA (@MargFranklin)
Margaret Franklin is the president of Marret Private Wealth Inc., a division of Marret Asset Management. Franklin has more than 20 years of institutional and private client investment management experience. She has worked at Barclays Global Investors, State Street Global Advisors, and Mercers in senior positions. In 2002, she moved from the institutional side of the business to work with private clients. Franklin is the former chairman of the board of governors of the global CFA Institute, is a past president of the Toronto CFA Society, and is a CFA charterholder. She has a BA in economics from McMaster University.
Robert Hagstrom, CFA (@RobertGHagstrom)
Robert Hagstrom, CFA is chief investment strategist at Legg Mason Investment Counsel and the author of the New York Times best-selling The Warren Buffett Way. He is also the author of The Warren Buffet Portfolio: Mastering the Power of the Focus Investment Strategy; The Essential Warren Buffett: Timeless Principles for the New Economy; NASCAR Way: The Business That Drives the Sport, and The Detective and the Investor: Uncovering Investment Techniques from the Legendary Sleuths. Robert’s new book is titled Investing: The Last Liberal Art (second edition) published by Columbia Business School.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
26 Comments
Hello Sebastian,
Thank you for sharing your point of view and for expanding the discussion with your inclusion of the Ponzi vehicles. Your views are closely in alignment with Robert Hagstrom's and he has written extensively about them if you want more information : )
With smiles,
Jason
Investing requires speculating. Investing as a contributor said on a different panel is outlaying capital. Speculating in making a guess (informed or otherwise) about the future. Investment decisions take place in a market place with incomplete information. Making a guess about the future is thus a necessary condition for completing the investment function.
From some of the comments, it appears the question raised tries to label investing as positive and speculating as negative. When one adopts the distinction as implied in the original question, a discussion of risk is required to support the distinction (high risk bad, low risk good). I believe this is not a constructive way to think about the investment function. Investment professionals have acquired and utilize tools necessary to make informed decisions with limited information. To throw out speculation entirely is to throw an entire body of knowledge in probabilities that civilization has developed over centuries and that a number of physical sciences rely on to make advances in their respective fields.
The distinction should be between investors who take the time to formulate and articulate an investment philosophy and process and spend considerable effort in understanding their investment opportunities before committing capital, and those who don't. During times of volatility the first group is likely to remain calm and let their numbers guide them; the second group is likely to head for the exit at any cost.
As with all professions, being honest with oneself and others is a sure way to remain on the positive side of any distinction.
Hello Amine,
Thank you for what you have written above. I especially like you highlighting that people can speculate without that being a negative endeavor. My own views, now revealed, post serving as moderator, are:
1. The future is unknowable for both the investor and the speculator.
2. Money may be made both investing and speculating.
3. Investing and speculating are essentially the same activity: risking current capital for the hope for more in the future.
4. Investing puts the greater proportion of mental responsibility on left-brain capabilities. Whereas, speculation puts the greater proportion of mental responsibility on right-brain capabilities.
5. Those undertaking the activity described in step #3 should identify what are their personal strengths, then they should develop tools that exalt their consciousness so that they are more effective as either investors or speculators.
6. Most of the differences between investing and speculating are easily described using common frameworks of different return expectations, risk tolerances, and investment time horizon preferences.
I actually really liked every panelist's contributions to the discussion. I liked Hagstrom's Cartesian grid of intelligent/unintelligent investing/speculating. I also liked Harold and Tom's emphasizing the relativistic aspects of the discussion.
For Harold, he emphasized that behavioral biases negatively effect capital allocations vis-a-vis return, risk, and temporal differences. I would point out that there is no reason to think that these behavioral biases would more effect any category of the intelligent/unintelligent investor/speculator framework.
For Tom, he thought that different market environments distorted notions of investing and speculating. I would argue that there is an absolute definition for these words and that is the value in having the discussion, so that when the market environment relatively distorts the absolute definitions then investors and speculators can better characterize the environment, then use this as decision making information.
I also really liked your emphasizing the importance of being honest with oneself and others. Well said!
With smiles!
Jason
Yes, a company's revenue, costs, cost of capital etc are all significantly affected by external factors. Customers, suppliers, input prices, financiers etc are in turn affected by more external factors like central banks, the government, the weather etc. Even physical phenomena like the climate can be influenced by things like consumption and environmental regulations.
As so goes the circle of life... Lots of assumptions made.
http://shareranks.com/499,The-Worst-Predictions-Ever
"Prediction is very difficult, especially if it's about the future." Nils Bohr
On the ponzi point, some companies in their early days went on without producing much cashflow or benefit for a while before they became succesful.
http://www.time.com/time/specials/packages/article/0,28804,2097462_2097…
Hi Roy,
Thanks for your continued contributions to the discussion!
Jason
Thanks for the comments of the panelists and commentators here. I would like to add my views here.
Another difference between investing and speculation is the definition of risk management. Investors emphasize on the movement of intrinsic value, whereas speculators care about pricing fluctuation (Beta/Sharpe/etc).
The panelists' comments are highly sophisticated, which is not understandable for the laymen. As a investment professional too, I would still prefer to look into investing-vs-speculation a simple context. Investing = buying a cow that milks every day and expect the value of cow to increase in the future; speculation = buying a cow and expect to sell next day/week/month/year by guessing how other buyers think.
As pointed out by many readers, speculation is all about guessing work. Speculators predict -- with and without reasonable basis -- the future growth, future market valuation, future economic environment, future human behavior, future bla bla bla. It is about predicting the future, in which the probability of error is at best 60-40 (normally 50-50). Therefore, speculation is generally risky, hence a speculating-CIO normally needs a risk management department sitting beside his/her office.
Investors, on the other hand, don't predict. Investors look into what an asset can produce and conservatively estimate the intrinsic value over the productions. At times, investors do predict future growth but with reasonable assumptions (conservative is the key). Any "investor" who predict growth without basis or with unreasonable basis should move to the speculation camp.