Investment strategy: speculating versus investing

Few gamblers make money. But if taking the occasional punt gives you some fun, then go ahead. We wouldn’t deny you the thrill. But be aware that it is a gamble, and gambling should not be part of your strategic investment planning.

U.S. biotechnology stocks have gained over 60 per cent this year, and a compound annual 42 per cent over the past three years. Some investors’ response is to take more and more risk. But before you jump at some of the more exotic funds now available, give some thought to their suitability to your circumstances.

An increasing number of funds now offer nothing but outright speculation on the future prices of various commodities, including gold and other metals, farm products, interest rates, and real estate.

Best long term investment strategy

We think investment success comes from buying stock of companies that produce products or services that people want, at a price they’re willing to pay. These firms create value. That doesn’t mean such a company’s stock price will go straight up; investors have different ideas of value from time to time. What’s more, most companies’ success comes in fits and starts, as economic conditions vary over the business cycle.

That’s why any best long term investment strategy requires time and patience.

However, we don’t think investment success comes from simple speculation on the future price of a commodity. If you buy gold bullion, for example, and store it away, you aren’t creating any value. In fact, you incur costs for storage and insurance.

Hedging is part of strategic investing

In commodity futures markets, a farmer may sell, say, his anticipated wheat harvest for future delivery at a fixed price. This is called hedging. It’s a process for getting rid of risk. By doing this, he can guarantee his future revenue. Then, by controlling his costs, he can, as he creates value, at least hope to make a profit. A bakery company may buy that same wheat for future delivery, to assure its costs. It can then plan its business in an orderly way, and, by creating value, it too can expect to make a profit. The bakery, like the farmer, is hedging, or getting rid of risk.

Gambling is not your best long term investment strategy

Often, however, suppliers and users do not get together to hedge, or reduce risk, on the same deal. A speculator may step in and assume that risk by, say, buying the future contract for the wheat. He obviously hopes the price of wheat will rise for some reason, and he’ll sell at a profit. He creates nothing, but simply transfers risk from others to himself. That’s gambling.

We know of few gamblers who make money. We don’t disparage the process, but if you participate, you should at least be aware of what you are doing before committing to it. And keep the gambling in your portfolio to an acceptable level.


The MoneyLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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