Recently I heard from an insurance salesman who scolded me for never giving any investment advice except to put all your money into “The Wall Street Casino.”
Over the past 23 years, I’ve penned scores of columns about the benefits of a diversified portfolio of asset classes (Wall Street being just one of them). Still, I would far rather invest 100% of my retirement funds in a diversified portfolio of US stocks than speculate on a roulette wheel. There is a big difference between investing and speculating.
I learned that difference the hard way when I was in my early twenties. I had some money in savings and some mutual funds in an IRA, but they weren’t building wealth fast enough for me. Gold prices were up and going higher, so I took $1000 out of my savings and put it into gold futures. In just a few days, my $1000 had turned into $3000.
My broker suggested putting the $3000 into pork bellies. I didn’t really know what they were, but he seemed to know what he was talking about, so I bought pork bellies. For a few days, everything was fine. Then the price of pork bellies tanked. For five days straight, the price fell so dramatically that trading was stopped at the beginning of the day. I couldn’t even sell. There was nothing to do except watch the losses pile up.
By the time trading resumed, I had a margin call for $12,500 ($50,000 today, adjusted for inflation). To pay it, I had to wipe out my savings and cash in my IRA. At least I had savings, so I didn’t have to go borrow the money.
I had made a classic rookie mistake—speculating instead of investing.
There are three things you can do with money you wish to set aside: save, invest, or speculate.
Saving is putting money away for future needs, often in a bank savings account or CDs. The primary purpose isn’t building wealth, it’s having money when you need it for emergencies or large purchases.
Investing is diversifying money into stocks, bonds, real estate, commodities, and other asset classes. The purpose is to build wealth over the long term, so investing is boring. While you will see the value of your money decline as well as increase, it is unlikely that over a long period of time you will actually suffer a permanent loss of capital. Your returns over time will probably be more than you would earn from simple savings.
Speculating is putting money into a high-risk investment in the hope of building wealth quickly. It’s exciting, dramatic, and risky. Examples of speculating include trying to time the markets through day trading, putting everything you have into one investment, and borrowing to buy stocks, real estate, or commodities. True, great fortunes have been made through speculating, but many more fortunes have been lost. Not only can you lose your initial investment, you can—as I did with my pork bellies—lose way more money than you had to begin with.
When novices skip from saving to speculating, chances are good that they’ll lose big. Unfortunately, too many of them learn the wrong lesson. They decide, “Investing is too risky,” never realizing they were speculating rather than investing.
As a result, in the future they may limit themselves to saving. Their money stays safe, but over time they lose in a big way, especially through decreased purchasing power. Investing is not a “casino,” but a way to earn the long-term returns that are so important for building net worth and achieving financial security.
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