Although I was selling real estate instead of attending college in my early twenties, I got a chance to pay a lot of tuition to educate myself about investing. 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. 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 beginner’s mistake: speculating instead of investing.
One way to look at planning for the financial future is to imagine it as a pyramid with three tiers: the bottom one is saving, the next is investing, and the third is speculating.
Saving is putting money away for future needs, often in savings accounts or CDs. The primary purpose isn’t building wealth, it’s having money when you need it for emergencies or large purchases. You don’t earn much in interest, but you won’t lose what you started with.
Investing is diversifying money into stocks, bonds, real estate, commodities, and other asset classes. The purpose is building wealth over the long term. Your returns over time will be more than you would earn from simple savings, but you do risk losing some of your original investment. Having a diversified portfolio minimizes the risk of ever losing all of it.
Speculating is putting money into a high-risk investment in the hope of building wealth quickly. Trying to time the markets through day trading and borrowing to buy stocks, real estate, or commodities are types of speculating. Another is putting everything you have into one investment. True, great fortunes have been made through speculating. More fortunes have been lost. There is a place for speculation in a diversified portfolio, but it’s a small place. 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 the “savings” tier. Their money stays safe, but they lose in a big way by not investing and earning the long-term returns that are so important in maintaining purchasing power, building net worth, and achieving financial security.
If unlucky speculators are luckier, they’ll realize, as I eventually did, that they have just paid some very expensive tuition. They’ll use the experience as a starting point to learn the difference between speculating and investing. Diversified long-term investors may not make huge fortunes overnight, but they do build wealth—and they sleep a lot better
while they’re doing it.