Record low interest rates, rich asset valuations, low inflation, and solid economic growth expected. The result? Speculative trading.
I’ve been getting more phone calls, emails, text messages and video calls from clients, friends, family and everyone else about purchasing speculative investments than I ever have before.
Now, the usual mantra is that by the time the retail investor gets involved, it becomes the pain trade. In other words if main street is finally rushing to plow their money into these investments as they soar in value, it means that there is likely nobody left to buy. It can be seen as a signal of a bubble or a market top.
Now I’m not going to say whether this is or isn’t a bubble, because that is beyond the scope of this article. Also I don’t feel like people using this later and claiming I was wrong.
However, we do need to go over how to spot the difference between making a successful investment, and simply getting lucky.
This first method. If you are investing in something purely because you have seen it go up in value and are afraid of missing out, you have to acknowledge that you are in no way shape or form investing. You are purely speculating. Now this doesn’t mean you can’t make money speculating, but it does mean you are effectively gambling and have to time your entry and exit points in order to make a profit, before greed gets in the way.
The second method is to calculate your odds of success and compare that to your payout odds. I like to use a simple dice game when explaining this. Your job as an investor is to find an investment whose odds are in your favour. If you wanted to bet me $10 that you could guess the number to come up on a dice roll, you would have a 1/6 chance of being correct. To be fair, you would want a 6/1 payday. If we rolled it 6 times, you would pay me $10 X 6 = $60. If you were right 1 out of 6 times you would get paid 6/1 6*$10 = $60. Which means if we did this over and over again, statistically neither of us would have made or lost any money as these are balanced odds.
If your investment has a 1/100 chance of working, but only pays out 20/1 those are terrible odds, even if you do successfully get paid 20x your money. If you can find an investment that has a 1/20 chance of working with a 100/1 pay out, then those are great odds and a very good investment.
You see, the reason people get lucky on speculative investments is that in the realm of statistics, anything that is possible to happen will eventually happen. For example, statistically speaking there is a chance of a racoon falling through your ceiling and landing on you in the next 5 seconds. Did it happen? No probably not, but here is the thing, it has happened, and it will happen again to somebody.
What this means is that with millions of people buying and selling random speculative investments all the time, their will always be someone who hits it out of the park even though the odds of it happening were absolutely abysmal. The reason you hear about it, is people like to talk about when it happens, or that they heard of it happening. Do you ever hear people brag that their 10-year return on their balanced portfolio was 7%? No? Because it’s not exciting. You’ll hear about how someone turned $1,000 in penny stocks into $1,000,000. Even though it only happened to 1 in 1,000,000 people who tried.
Remember, just because you have heard of someone making lots of money on a speculative investment does not mean you should rush out and buy it. If you are comfortable with a small percentage going into speculative investments, then make that decision. However, don’t let the emotional fear of missing out dictate your investment strategy.