I hesitate to jump too far into general principles of investing, since at this point I have not yet covered all fundamental preliminary information that needs to be addressed prior to investing. There’s a lot more to cover beyond just the first step to becoming an investor.
But because the current COVID-19 pandemic that began earlier this year brought out so many new “investors” en masse, I thought it would be beneficial if I were to go ahead and address this important topic sooner rather than later.
To begin, ask yourself this question: “Am I an investor or a speculator?”
One of the important principles to understand in investing is the difference between investing and speculation. When we invest, we are committing our money to something in the expectation of earning a return over the long term.
In other words, we have a reasonable expectation that whatever we are committing our money to is going to succeed over the long term by virtue of the fundamentals underlying the business, bank, financial instrument, etc. in question.
In contrast, speculation is when we are committing our money to something we hope will rise in value quickly and exponentially due to its higher level of risk or (what we hope to be) high demand.
Speculation is focused on the short-term because there is no guarantee that something that rises in value so quickly will either (1) maintain that level of growth without regression, or (2) remain at that higher price over the long term. So when we speculate, we commit our money to something that is inherently riskier (than investing) in hopes of achieving a high return in a short period of time.
When you think about these from the perspective of biblical stewardship, in particular, I think it is easy to see that one lends itself toward a right understanding of stewardship more than the other does.
In investing, we are looking to build wealth slowly and methodically over time, both to meet our future living expense needs and other financial goals, and to place us in a position for greater kingdom impact with the resources we possess.
In speculation, we are looking to enrich ourselves quickly and easily, and willing to incur greater risk (of losing our money) in the attempt to do so, which is actually contrary to good stewardship.
Speculation and the love of money–or what Paul refers to in 1 Tim. 6:9 as the “desire to be rich”–go hand in hand. The reason I bring this up in relation to this post is because what you will have observed since around the beginning of the COVID-19 pandemic is that there is a lot of speculation going on, particularly among millennials and Gen Z.
Quite frankly, many have been interested in making quick money by trading stocks, while few have been interested in long-term investing as a matter of good stewardship.
You’ve probably read stories about the recent flurry of stock trading in the news, such as the explosion of the number of new Robinhood accounts (Robinhood is a discount brokerage especially popular among younger users), or the young Robinhood user who committed suicide when he mistakenly thought he was on the hook for several hundred thousand dollars when trading options (I can assure you that I will never teach you anything about trading options on this blog).
I want to caution you, reader, regardless of age, that doing things like opening a Robinhood account (not wrong in and of itself, per se) with the intention to day trade stocks at zero commission for what you hope are quick and meteoric profits is speculation. It is not investing.
Why would doing so not constitute investing, though? Here’s an example of what speculation can do and just how different it is from investing. Note that I don’t mean to pick on Robinhood users, so don’t think I am, but I’m using Robinhood data because it is illustrative of the surge in speculation among inexperienced “investors” during the pandemic (again, most of whom are young).
On May 22, Hertz, the rental car company, filed for bankruptcy, which sent their already declining stock plummeting even further to less than $1 per share. Between Friday, Feb. 21, and that point, the stock declined somewhere around 95%.
A 95% decline in stock price in roughly three months? Hertz was seriously hurting (no pun intended) and in a world of trouble due to the pandemic, which understandably drove the demand for rental cars down to near zero: no one traveling = no one needing rental cars.
Yet over that roughly three-month period, despite the decline and despite the bankruptcy filing, something curious happened. Robinhood users actually bought Hertz stock in droves. Yes, you read that correctly. Robinhood users went on what effectively amounted to a shopping spree on Hertz stock.
In February, approximately 1,000 Robinhood users owned Hertz stock. At the beginning of June, around 60,000 Robinhood users owned Hertz stock. In fact, right after Hertz filed for bankruptcy on May 22, that period through the end of May alone accounted for a jump in 15,000(!) Robinhood users owning Hertz.
Now what could possibly drive the declining stock of a failing company that eventually filed for bankruptcy from 1,000 owners to 60,000 owners on a single trading platform in roughly three months with roughly 1/4 of that increase taking place in the span of about nine days? If you guessed “speculation,” you’re exactly right.
Robinhood users saw a distressed stock at a rock-bottom price and thought, “Surely the price of Hertz stock won’t stay this low for too long. Surely it will rise again significantly as the stock market recovers, things return to normal COVID-wise, travel picks up again, etc. I’ll ride the stock back up and make money.” So they bought the stock on the hope of a relatively quick turnaround. Speculation.
But I would even go so far as to say it’s not just speculation alone we’re talking about here, but also speculation combined with ignorance (which is frequently the combination). Why do I say that? Consider these facts.
Prior to filing for bankruptcy, Hertz had accrued $19 billion in debt, had lost $58 million in 2019 alone, and had either furloughed or laid off 25% of their workforce due to the pandemic by the day they filed for bankruptcy.
Now if you had to guess, how many of those 59,000 Robinhood users who bought Hertz stock between February and June knew the above information before hitting the “buy” button? How many of those users knew that information after they bought? How many of them understood any of the fundamentals used to measure a business’s performance in the first place?
What’s even worse: How many of them understood that in corporate liquidation due to bankruptcy (a bankrupt company going out of business and selling all assets to pay creditors), secured creditors, including those who hold the company’s bonds, are paid first, unsecured creditors, such as the banks and suppliers the company does business with and even its own employees, are paid next, and shareholders are paid last?
How many of them understood that most often, in such instances, the liquidated assets are 100% depleted well before even getting to the shareholders, leaving the shareholders with nothing but worthless ($0) stock? How many of them who still hold Hertz right now even understand this?
Again, dear readers, what I am describing here is not investing. It’s speculation, and it should be abundantly clear that the users engaged in it in this real-life, recent example are simply trying to make a quick profit on a (most likely doomed) hope that the distressed stock will quickly turn around and experience exponential growth.
This is a far cry from sound investing in a well-diversified, risk-appropriate portfolio, which is exactly what I’m going to teach you how to do through this blog. Between investing and speculation, one will most likely help you reach your financial goals over the long term, and the other will most likely leave you broke.
Choose wisely.
Next post: “Am I Ready to Invest?” Part 1: The Emergency Fund