What the heck is an investor, anyway?

What is an investor/investment?

"Investing in a solid pair of shoes is a good idea."
"I might invest in a nice gaming computer."
"Designer makeup is a worthwhile investment."

The word "investment" is used pretty often in our daily lives and in the media. But what is an investment? Benjamin Graham defines an investment in his 1934 book Security Analysis as, "a financial operation that, upon thorough analysis, promises safety of principal and a satisfactory return." So Graham broke the definition down into three parts: research, safety of principle, and a good return.

An investor seeks these three goals:

With research, you begin to understand exactly what you are getting yourself into. Research of a company, when you are considering purchasing a stock, is important. It could lead you to realize the company has tons of debt, and might be in bad financial condition.

Safety of principle means insuring that your initial investment is not lost. If you are investing $100 in stock of a company, you don't want to end up losing your $100 because the stock was too risky. Gaining very little is preferable to losing anything.

Adequate Return means that you gain money on your investment that is satisfactory to your goals. Obviously this is somewhat of a broad term, but indexes can help you understand how well you are doing. If you compare the return on your stocks after 1 year with the return of the S&P 500 index, you can get an idea of how good of a return you have achieved. For most mutual funds and individuals, just beating the S&P 500 by 1-2% is a huge achievement.

So basically, an investor is someone who makes an investment with those three ideas in mind.

The way in which these goals are achieved are extremely vast. Investments can range from stocks to gold to real estate. You could even invest in coins or collectibles which you think will rise in value over time, but that is another hobby.


The difference between Speculators and Investors

As mentioned in the previous post, called "Hey! You're Not an Investor! Get Outta Here!", speculators are not investors. To elaborate on this topic, consider what speculators hope to achieve in relation to the investor. A speculator's goal is to make money by gambling his or her money on the idea that an asset will appreciate in value. This goal is usually sought after by purchasing risky assets. By doing this, the speculator hopes to gain a much higher profit than if they would have invested in a low risk asset. The problem here is that with high potential for profit, comes high potential for loss. Additionally, the high gains that speculators can make are not usually sustainable over a long period of time. Think decades. What is the point of making a ton of money, if you just end up losing it a few years later?

Essentially, speculators seek very high returns, but without seeking safety of principle. Without seeking safety of principle, gains cannot be sustainable over long periods of time.

Stay Tuned!

My upcoming posts will discuss different types of investors, investing on a college budget, and more about the methodology of value investing. Don't worry, I'll manage to find some good recommendations for s'mores soon!

Hey! You're not an investor! Get outta here!

What an investor is NOT

Wall Street uses the word "investor" with reckless disregard for the true meaning of the word. To Wall Street, an investor can be many types of people. Often times, Wall Street confuses the investor with the speculator. In Security Analysis, Graham discusses this issue by stating investors judge "the market price by established standards of value," while speculators "base their standards of value upon the market price." Speculators essentially gamble on stock prices, hoping they will make money. Would you be comfortable with gambling on your stream of income for the next several years? I hope not!

Anyway, let me show you some examples of how Wall Street distorts the idea of the investor:

• T.D. Ameritrade Commercials - "Independence is the spirit that drives America's most successful investors." Notice how TD's use of the term investor is contorted. If you have watched one of their commercials, it is easy to notice that the people depicted are clearly either "traders" or "day traders". Traders and day traders are NOT investors. Traders are speculators. They use methods like technical analysis, to see how the stock prices are moving, not how the value of the underlying company looks or has changed. The idea of being an investor is to focus on long term, sustainable gains. The trader keeps short term, weekly or monthly gains in mind. These gains are almost never sustainable for long periods of time. To top it off, individual traders drown themselves in trading costs and taxes inherent with buying and selling stocks frequently. Note: These costs and fees do not apply to institutional traders, as they work on Wall Street.
  

• E*Trade Commercials - I'm sure you've seen the TV commercials with the baby talking about how easy it is to buy stocks using E*Trade. This is another example of a trader. The commercial doesn't mention trading costs, valuation of stocks, or even thinking about what your buying. After all, if it is easy to buy a stock, that means you will make money right? Hah, I wish.

I realize these are only two examples, but can you see what I mean? Many "reliable" sources of Wall Street news will throw around the word "investor" when they actually mean "speculator". It is important to differentiate between these two, as I will only be discussing investing in my blog.


Traders and Day Traders

Now don't get me wrong, a skilled (and small) number of traders can and do make boatloads of money. The downside is that often times these gains are not sustainable over a period of decades, think 30 years. The long term is where value investing really shines.

One reason Wall Street does not generally like value investing is because it does not like thinking long term. Wall Street enjoys the daily, exciting, and drama-filled activities of the markets. I don't know about you, but I'm not really the kind of person who enjoys getting overexcited or depressed about daily occurrences that don't mean a whole lot in the long run. Wall Street loves to publish daily articles about what companys' stock is going up, where analysts think stocks will go, and why you should buy stock XYZ.

Please, don't just buy everything that Wall Street says (no pun intended). Think for yourself, and do your homework!