Confusing Speculating With Investing IS Hazardous to Your Wealth
Mickey Kim / August 6, 2021
There’s a whole industry built around convincing you investing is as easy as child’s play and you can trade your way to prosperity, all for free.
Whether it’s the very clever and entertaining “Don’t Get Mad, Get E*Trade” ads featuring dogs or talking babies, TD Ameritrade offering you an “in-depth,” 30-second “Strategy Gut Check” before you click “BUY” on your phone app or Robinhood’s self-righteous “We Are All Investors” commercials, it’s the same seductive siren song that everyone is getting rich but you.
There is a big and critically important difference between trading/speculating and investing. Speculators may or may not know anything about an asset, but buy it on a hunch or because a celebrity is promoting it or everybody else is buying it and it’s going up without me (“FOMO”). They crave the thrill of the “home run” by purchasing assets like Bitcoin that will never produce anything in the hope the pool of like-minded speculators, who also know Bitcoin will never produce anything, will expand and enable them to sell it at a higher price.
By contrast, investors are content to stay within their “Circle of Competence” and buy productive assets with a sound fundamental case for a reasonable rate of return. They play the boring “long game,” trying to hit singles and doubles and letting the “miracle of compound interest” put runs on the scoreboard.
Albert Einstein referred to compound interest as the “Eighth Wonder of the World.” Investors love the related “Rule of 72,” which states by simply dividing 72 by your assumed interest rate/rate of return, you get the number of years it takes to double your investment. At 6%, it takes 12 years. At 9%, it takes 8 years. Invest $10,000 @ 9%. After 8 years you have $20,000, after 16 years $40,000 and 24 years $80,000.
Today, most folks would scoff at an 9% return, but you can see what a powerful financial lever compound interest can be, if you let it. Whatever your return assumption, it’s better to start sooner rather than later. You want to let compounding work as long as possible for you.
I have no quarrel with speculating and understand the periodic need for some folks to scratch that itch, as long as it’s recognized as such and confined to a relatively small “play money” account. Similarly, I occasionally venture to a casino, where I understand I’m likely to lose when I gamble and the “free” cocktails aren’t really free. The casino is there to entertain and doesn’t masquerade as a place where you risk serious capital on investments.
Robinhood’s (NASDAQ: HOOD) highly-anticipated IPO on July 28 not only didn’t “go to the moon,” the shares promptly flopped by almost 10% from the $38 offering price. While it’s true Robinhood doesn’t charge commissions on trades, it profits by routing customer trades to market makers like Citadel Securities for execution, a controversial practice called “payment for order flow” (PFOF—UK outlawed in 2012), currently in the crosshairs of US lawmakers. The more “free” customer trades Robinhood routes, the more the market makers pay to Robinhood. Indeed, Robinhood received $331 million in PFOF (accounting for a whopping 81% of revenue) in the first quarter of 2021 alone.
Robinhood has a troubled regulatory history. Last December Robinhood agreed to pay $65 million to the SEC to settle charges it had misled customers by making false and misleading statements about how it makes its money (i.e., from PFOF). Additionally, Massachusetts securities regulators filed a complaint accusing Robinhood of using “aggressive tactics to attract inexperienced investors” and “gamification strategies to manipulate customers.”
Just a couple weeks ago, Robinhood agreed to pay nearly $70 million to settle sweeping regulatory allegations that it had misled customers, approved ineligible traders for risky strategies and didn’t supervise technology that failed and locked millions of its customers out of trading.
In response to critics, Robinhood protested, “In one fell swoop an entire new generation of investors has been criticized and this commentary overlooks the cultural shift that is taking place in our nation today. Robinhood was created to allow people who don’t have access to generational wealth or the resources that come with it to begin investing in the U.S. stock market. To suggest that new investors have a ‘mindset of racetrack bettors’ is disappointing and elitist.”
As Shakespeare wrote, “the lady doth protest too much, methinks.” You have to trade to invest, but just because you’re trading doesn’t mean you’re investing.
The opinions expressed in these articles are those of the author as of the date the article was published. These opinions have not been updated or supplemented and may not reflect the author’s views today. The information provided in these articles does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular stock or other investment.
Subscribe to stay up to date with the latest news, articles and newsletters from Kirr Marbach.