The idea of investing is simple. Move money from the present to some time in the future. Find a financial tool that moves it and enhances it during the journey. What could be easier?
Well, as it turns out, almost anything could be easier. The money enhancing time machine relies on markets and markets tend to be unpredictable in the short run. We equate the inability to predict with risk. In some ways that is reasonable, but once you realize that the investment is not money you will be on the road to understanding.
Markets offer the opportunity to put money in and to take money out, but while it is there, it is not money. All you have is the option to exchange your market holding for money and whatever it bought. That is where the uncertainty is. How much money?
Markets are made up of people. All their knowledge and all their hopes, fears and aspirations. As these are unknowable in detail, the market is fuzzy. You can see the general idea of it, but you cannot see precise movements. Especially not the when of the movement.
Investors must recognize and accept their fallibility and take action to avoid permanent losses. The hard part is distinguishing between permanent losses and transient losses. That skill is a bit uneven. Consider this:
“Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions.”
Another problem. Semantics matter. People use investing and trading interchangeably. They are not the same.
Investors operate within the market as a whole. They participate. They buy shares of businesses, or they buy debts of businesses and other institutions and accept lower returns for lower risk of permanent loss.
Traders on the other hand, play against other traders. The long term value of the market as a whole is not relevant. They play against other traders who they estimate will know less, or will know it later, or will misinterpret it.
The difference is that in buying stock you can assess business management, financial structure, the industry, competition, pricing, future cash flow and more. In trading you must know and understand the nature of all the other players in the marketplace. Business principles normally play out in the long term while trading profits happen more quickly and only if you understand the fear and greed motivators of the others.
Investing successfully requires skill, knowledge and discipline. Do not assume it is easy. It is not. See Buffett above once more. Or maybe Jim Ling’s discussion of his huge business imploding. “I was right twelve times and only wrong once.”
If you cannot provide all of the necessities of investing, seek an assistant.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.