In investing, as in life, honesty really is the best policy. Only through truthful introspection and honest self-criticism can you take stock of your position, however good or bad, and devise a plan to move forward. Lies tend to require subsequent lies to prop up their illusion of credibility, until they spiral out of control and eventually lead one to a dead end. Truth usually stings at first, but in the end it is the only path to progress.
So before we get down to topics like philosophy, fundamental analysis and stock picking techniques, we need to answer the primary question upon which our entire investment approach will find its foundation: are you a gambler, trader or investor?
Take the test
Below are three tables that will help you to determine whether your behaviour in the stock market is that of a gambler, trader or investor. Each table contains a number of statements with a ‘YES’ and ‘NO’ block beside each one. Answer ‘YES’ to statements that describe the way you invest and answer ‘NO’ to those that aren’t true for you. The tables are not exhaustive, but they will give you a pretty good idea of where you fit in right now. Take the test and then read on. Be honest now...
| Gamble – to risk money on the outcome of something involving chance | ||
| Statement | Yes | No |
| You do little or no research on the stocks you buy |
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| You buy stocks on a hunch or on tips you’ve heard at dinner parties |
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| Returns – you hope to hit the big time and double your money (or better) by buying a great stock |
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| You sometimes take a chance and buy on gut feel |
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| You do not consider investment horizon (how long you will hold the stock for); you care only about hitting the big time |
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| You believe that there is something innate in you that when a stock you own goes up it is because of you, or something in you, that it went up |
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| You are looking to make a quick buck |
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| You think that making money on the stock market is easy |
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| When you are down you double up or buy more of that stock just to recover your losses or prove to yourself that you were right |
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| You experience high highs and low lows in your psychological or emotional state depending on the performance of your stocks |
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| You frantically seek new sources of money to place in the stock market |
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| Trade – to buy and sell | ||
| Statement | Yes | No |
| You watch your trading account and portfolio’s performance almost every day |
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| You do not consider yourself a part owner in a company; rather you view your stocks as instruments you hope to sell to someone for more than you paid |
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| You carefully watch daily and short term movements in stock prices and those movements motivate you to trade |
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| You place importance on quarterly earnings numbers and would consider selling your stocks if the company reports below-consensus quarterly earnings |
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| Returns – you expect to buy at a low price and sell at a higher price and you hope to turn these stocks over in the shortest period possible |
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| Research – your research is focused more on statistics like PE ratios, historical high and low stock prices and volatility and less on company earnings and fundamentals |
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| Dividends play little or no part in your investment decision |
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| When you buy something you are already thinking about what you could sell it for |
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| Your trading activity is high; you continually switch in and out of stocks |
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| When a stock has performed well you sell it in the pursuit of ‘profit taking’ |
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| You don’t limit the type of stocks you would buy according to a predetermined philosophy; rather you are prepared to buy any stock that looks cheap |
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| Invest – to put money to use in something that offers a profitable return | ||
| Statement | Yes | No |
| You research a company thoroughly before buying their stock – reading annual reports and research reports, doing industry and competitor analysis etc |
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| You consider yourself a part owner in an actual company |
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| When you buy stocks, you plan to hold them for a long time – at least 3 to 5 years |
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| You are interested in receiving dividends in addition to possible capital growth in the share price |
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| Your expected returns are modest and sustainable – i.e. You expect to make a return equal to, or slightly above, the market return |
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| You consider the company’s financial history as well as prospects for the future |
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| You understand and expect that share price growth will track earnings growth in the long term |
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| You follow the performance of the companies you own but only sell stocks if there is a shift in the long term prospects |
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| You consider qualitative factors in the investment decision like pricing power, competitive advantage and quality of the product or service offered etc |
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| Your trading (buying and selling) activity is low |
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What do you want to be?
A little shocked at how much of your behaviour represents that of gamblers or traders? Don’t be alarmed or become despondent. No investor is perfect and we all tend to have a disjointed approach to managing our portfolios, especially when starting out. The first step is to acknowledge where we’re at. The second step is for each investor to decide what they want to be – a gambler, a trader or an investor. On that note, here’s my personal opinion on each of the categories:
Gambling – I believe there are no apparent benefits to gambling (casinos are the ones that make money, not the gamblers) and I would strongly advise every investor to steer clear of gambling-type behaviour. Gamblers are just as likely to lose their money in the stock market as they are at a slot machine.
Trading – there is money to be made in the short term trading of stocks, but be warned – it is time consuming, very stressful and extremely taxing on your psychological state. You will constantly be evaluating and re-evaluating your positions and will need to have an eye on the market all the time. Also, in the short term, one is reliant on the behaviour of other buyers and sellers to move share prices and, contrary to popular theory, their actions are not rational. So if you choose to be a trader in the stock market, know the risks and proceed with caution – trading stocks is essentially no different to trading second-hand cars.
Investing – investing requires hard work, patience, insight and persistence. However, the benefits are great. There is little that is more satisfying than having thoroughly investigated a particular stock, purchased it and then having the confidence to leave it alone for 5 or 10 years, watching it accumulate value and pay dividends.
In conclusion
I believe that being a long term investor is the least stressful and most secure way of using the stock market to create wealth. In the long term, the benefits will surpass those of trading or gambling.
Editor’s note:
Watch out for the next article in Nicolas van der Meer’s series in which he provides a step-by-step guide to creating a long-term investment portfolio.