Intelligent Investor #1: Do not Confuse Speculation with Investment

This first article is based on my reading of The Intelligent Investor*. One of the two books I consider as a key reference to learn the basics of finance.

In The Intelligent Investor, Graham defined investing as the “operation that upon thorough analysis promises safety of principal and adequate return“.

 

Graham’s Three Criteria of Investment

  1. Analyze the value of a company and soundness of its business;
  2. Protect yourself against serious losses;
  3. Aspire to adequate—not extraordinary—performance (Be reasonable and regularly ask whether the value of the company’s underlying businesses has changed).

 

Difference between investment and speculation

Investment and speculation are two different ways to buy stocks. Investing is wise and will consist in a long-term investment. Speculating is an entertaining activity, which can produce lots of adrenaline.

Investment = Strategy based on value of the company’s businesses (value driven);
Speculation = Gamble based on the mere expectation than the price will go up because somebody will pay more (price driven).

“Intelligent speculation” is possible. Keep in mind that you should remain aware that you are speculating—not investing—and you should not to risk more money than you can afford to loose. Speculation is more an entertainment than a wise way to become richer.

 

Be cautious with fashionable strategies

As an intelligent investor, you must be right for while in order to reach your long-term financial goals. Therefore, avoid the following: short-term strategy, hot mutual funds, day trading, and stock-picking system—especially if it is in fashion. If it works, it is only because one is temporarily right—or is lucky. This is not sustainable.

 

What happen when a share price has fallen?

Investment leads to a long-term approach. As you invest, you do not expect an overnight increase of share prices.

If a specific share price just fell, do not sell immediately. Instead, consider whether the value of the company’s businesses has changed. Then react accordingly.

 

Take Away

1. Invest if you want to become richer.
2. Speculate if you want to have fun. Be aware that you are speculating. Do not be mistaken about how sure you are about the success of your strategy.

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*The Intelligent Investor is the first step of becoming an intelligent investor. We will continue to refer to this book in the following articles. Seasoned investors such as Warren Buffett or Peter Flynch consider this book as a must-have. Do not miss any opportunity and buy it now.