Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 373

To speculate or not to speculate

“Tips! How people want tips! There is greed involved, and vanity.”

-Edwin Lefevre, Reminiscences of a Stock Operator, published in 1923

The launch of electronic brokerages spawned day-trading for regular people back in the 1990s, and the advent of low-cost and free brokerage took things to a whole new level this year.

But speculating on markets goes way back. It was almost a century ago that journalist Edwin Lefevre wrote the investing classic Reminiscences of a Stock Operator, documenting the perils of stock market speculation.

And it has been more than 80 years since Ben Graham, the father of investing and Warren Buffett’s teacher at Columbia Business School, first split the world of markets into two classes: investors and speculators.

Graham said an investor is someone who wants preservation of capital and an adequate return. Everyone else is speculating. It’s a distinction that is more important than ever today.

The Australian Securities and Investments Commission (ASIC) recently conducted a review into 2020’s sudden surge in stock market speculation as ASIC grew increasingly concerned about the risks being borne by small investors.

The findings of the review were extraordinary

Not only are small investors trading more amid the COVID-driven volatility in markets, but many are setting up brokerage accounts for the first time. More people getting involved in markets is normally something for the industry to celebrate but there are some concerning features about the new generation’s taste for risk.

For starters, the average daily securities market turnover by retail brokers has doubled this year. ASIC studied a period of six weeks at the start of the COVID-19 crisis in Australia when the Australian Securities Exchange indices fell by more than a third from their record high.

During the period, turnover from retail brokers hit a daily average of $3.3 billion, up from $1.6 billion in the previous six months.

More surprising was the finding that as the markets fell, retail clients were buying. Over the period, retail broker clients bought $53.4 billion worth of shares and sold $48.4 billion.

The net buying behaviour coincided with another interesting statistic: many of the buyers were in the market for the first time. ASIC tracks ‘unique client identifiers’ in the market. During the early part of the crisis, an average of 4,675 new identifiers appeared in the market every day. The rate of creation of new accounts was more than three times higher than before the crisis.

The results were clear: a heady combination of working from home, access to cheap broking accounts and volatile markets tempted many to try their luck.

But for most, it didn’t work out. ASIC concluded that if all retail investors held all their positions for only one day, total losses for the six weeks would have hit $230 million.

It’s a salient lesson and one Vanguard has been prosecuting for decades. Market speculation – whether through day trading or mere market timing – poses clear risks to financial health.

The first risk is that people are notoriously bad at timing itself. Timing the market is always tempting. If we could only pick the highs and lows, we could dramatically improve returns. But hindsight makes timing an illusion. The future remains uncertain and repeated studies have shown that even professional investors struggle to time the market.

The ASIC study bears this out. Two thirds of the days on which retail investors were net buyers were followed up by a day of falling share prices. Half of the days when they were net sellers were followed by an up day.

Here’s another problem faced by many direct investors: concentration. People who take a trading approach to their investments can end up with a collection of assets that have been accumulated over time without regard to how they fit together as a portfolio.

This can lead to a portfolio that is overweighted to a particular asset type or industry, increasing the risk of permanent loss of capital should things go wrong.

ASIC also notes that many investors are being tempted into high risk products that use leverage to supercharge returns.

Geared products increase the profits from favourable market movements but magnify the losses when things go the wrong way.

ASIC says some 75% of trading in one geared exchange traded product earlier this year was by retail investors, who pushed it to become one of the most traded products on the market.

This appetite for risk also tempted some into volatile, speculative investments based on commodity prices. Some oil futures products lost 80% of their value in a few weeks, potentially wiping out investors who never intended to actually take delivery of the oil.

Have you been tempted by the wild west mentality of 2020? Have you found yourself straying from your investment principles and taking a punt?

Five simple rules for investors

Here are five ways to get things back on track.

First, remember the difference between investing and speculating. Investing means holding assets that will provide you with an adequate return over a long period of time in a mixture of income and capital growth. It doesn’t mean chasing short term profits.

Second, revisit your original investment plan – or create one – and bring discipline back to your investing. Having clear, appropriate investment goals and a considered roadmap to achieve them is the core to successful investing. Portfolios need to be built from the top down – considering risk, return and diversification – and not built up as a collection of individual assets.

Third, be diversified. Diversification protects you against permanent loss from something going wrong in a single investment. Diversification means owning different investments in different industries, different countries and different asset classes.

Fourth, keep an eye on how much is leaking out of your portfolio in fees. Fees include brokerage, advice fees and fund manager fees. These all eat at your capital. Fees are the single best predictor of outperformance of a managed fund. The lower the fee, the better the outperformance.

Fifth, remember that earnings usually grow over time and that compounding works.

Sticking to the core principles of successful investing can get your investments back on track to deliver your goals.

 

Robin Bowerman is Principal and Head of Corporate Affairs at Vanguard Australia, a sponsor of Firstlinks. This article is for general information and does not consider the circumstances of any individual.

For more articles and papers from Vanguard Investments Australia, please click here.

 

RELATED ARTICLES

Why not all share platforms are created equal

Online broking: same game, different players, lower cost

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

The greatest investor you’ve never heard of

Jim Simons has achieved breathtaking returns of 62% p.a. over 33 years, a track record like no other, yet he remains little known to the public. Here’s how he’s done it, and the lessons that can be applied to our own investing.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

Latest Updates

Shares

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Property

Baby Boomer housing needs

Baby boomers will account for a third of population growth between 2024 and 2029, making this generation the biggest age-related growth sector over this period. They will shape the housing market with their unique preferences.

SMSF strategies

Meg on SMSFs: When the first member of a couple dies

The surviving spouse has a lot to think about when a member of an SMSF dies. While it pays to understand the options quickly, often they’re best served by moving a little more slowly before making final decisions.

Shares

Small caps are compelling but not for the reasons you might think...

Your author prematurely advocated investing in small caps almost 12 months ago. Since then, the investment landscape has changed, and there are even more reasons to believe small caps are likely to outperform going forward.

Taxation

The mixed fortunes of tax reform in Australia, part 2

Since Federation, reforms to our tax system have proven difficult. Yet they're too important to leave in the too-hard basket, and here's a look at the key ingredients that make a tax reform exercise work, or not.

Investment strategies

8 ways that AI will impact how we invest

AI is affecting ever expanding fields of human activity, and the way we invest is no exception. Here's how investors, advisors and investment managers can better prepare to manage the opportunities and risks that come with AI.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.