Investing isn’t always easy and 2016 has certainly proven that volatility in the stock market can lead to significant shifts in investor sentiment and philosophy. A correction of this nature should be viewed as an opportunity to analyze your current strategy to ensure its measuring up to your expectations.
What it should not do is cause you to deviate from a sound philosophy of investing to a gamblers streak of speculation.
Let me explain what I mean by that….
Investing is when you create a rational plan to grow your earned capital through a systemic process of investment in multiple securities or asset classes. It may include converting your cash to stocks, bonds, commodities, mutual funds, or ETFs in a manner that conveys a disciplined approach to risk management alongside a defined process and time horizon.
For most investors this simply means building a balanced portfolio that takes into account their specific risk tolerance, experience, and goals. That plan will then be subtly adjusted over time as your life changes, you accumulate or redeem capital, or your philosophy takes on a different form. The themes change, yet overall, the basic building blocks of investment in the stock and bond markets have been similar for generations.
Speculation on the other hand is when you take out a lottery ticket.
It’s a completely different mindset that is more akin to gambling rather than true investing. You don’t wake up one day and put $5,000 in the Direxion Daily Gold Miners Bull 3x ETF (NUGT) as a long-term investment opportunity. You do it because you think you can make a killing in a very short period of time.
This chart should show you why:
Sometimes that opportunity pays off through timing and maybe even a bit of skill in reading the fundamental or technical tea leaves. Other times you get scorched and end up selling at a loss with a big helping of regret and earnest promises to never to do it again.
The former is honestly far more damaging than the latter. Bear markets bring about a sense of frustration with the fact that the normal system you have relied on for years is not working. But you keep hearing about those guys trading gold stocks, volatility futures, Treasury contracts, leveraged ETFs, bear funds, and options bets that are making a killing.
Naturally you ask yourself, why can’t I do that too? I can own all those types of investments through an ETF in most of my retirement or brokerage accounts.
So you buy a little NUGT or ProShares Ultra VIX Short-Term Futures ETF (UVXY) or AdvisorShares Active Bear ETF (HDGE) and BOOM in a matter of a few days it jumps 15%. You sell, bank the profits, and all is right with the world.
Suddenly this speculating stuff doesn’t seem so hard. In fact, you can probably fire your advisor or redeem your basket of diversified stocks and bonds. Timing the market is easy when you only have to hold for a couple of days and can magnify your returns! No more riding through those pesky bear markets or fretting over rising interest rates. It’s a whole new world.
Of course, that last paragraph is totally in contrast to my true beliefs. Speculating in high risk investments is one of the last things you should be doing as volatility expands. Even though you may hit a few singles with some well-timed trades, the same correlations and patterns you are using to time the market may look completely different a few weeks from now. It’s just as easy to experience a double digit percentage drop in leveraged or inverse funds as it is to make that much on the upside.
This same mantra holds up for individual stocks too. There is a big difference between buying Yahoo! (YHOO) because it has fallen 50% and you are hoping for a face ripping bounce or buyout offer rather than because you love the platform and think it’s a solid long-term company to own. Make sure you consider your motives before putting money to work as unintended price action can have deleterious effects on your decision making process once you are committed.
I think it’s also worth noting that trading does not automatically equate to speculating. There are some very methodical traders with short-term time horizons and a risk-aware approach that are candidly investing in a more active manner. The difference is that they have time, tools, and discipline that have been honed by experience and the most successful stay within their refined process.
Remember that volatility is not a transient event. It is something that is constantly with us and causes the market to move both up AND down in unpredictable ways. If you have found yourself straying from a sensible portfolio strategy, take the time to evaluate your decisions to determine if you are making changes for the better or possibly worse. Sometimes that simple exercise is all you need to snap back to reality and re-focus on a plan that makes sense to reach your goals.
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