When you hear about someone making a fortune in the stock market practically overnight, don’t you sometimes think, “Why can’t that be me?”
We saw it again in recent days.
In brief, a group of “wolf of Wall Street” types were betting against GameStop, the video game retailer. They were hoping to make millions when the company’s stock dropped. This tricky but legal practice is called “shorting” a stock.
That’s when a group of young investors on the Reddit forum r/WallStreetBets decided, “Let’s take down a hedge fund!” Using the app Robinhood—which lets small-time speculators trade stocks commission-free—these Millennials started snatching up cheap GameStop shares, pushing the stock price WAY up.
Consider: On January 5, GameStop was selling for $17.37 per share. By January 27, the price had soared to $347 per share!
In a matter of days, a giant hedge fund was down billions of dollars, and a group of “regular Joes” were multi-millionaires! It became one of those David vs. Goliath tales Americans love so much.
Of course, the party never lasts forever. The big boys screamed “Foul!” Regulators started investigating. Robinhood stopped the trading of GameStop and several other stocks. By February 4, GameStop’s share price had dipped to $53.50.
While we wait for the Netflix movie (yes, one is already in the works!), we’re left to sort through the lessons here…the biggest one being:
Speculation and investing are not the same thing.
Speculation is to investing what yelling is to conversation. In both, the mouth is used to say words, but the tone and expectation is very different.
I like what portfolio manager Ben Carlson has written about investing:
“The stock market is the only place where anyone can invest in human ingenuity. It is a bet on the future being better than today. Stocks can be thought of as a way to ride the coattails of intelligent people and businesses as they continue to innovate and grow. Short of owning your own business, buying shares in the stock market is the simplest way to own a slice of the business world.”
Carlson continues, “Many people compare the stock market to a casino, but in a casino the odds are stacked against you. The longer you play in a casino, the greater the odds you’ll walk away a loser because the house wins based on pure probability. It’s just the opposite in the stock market.”
So, what exactly is speculation? It is the purchase of a thing (land, stocks, tulips) in hopes the price will quickly rise, affording a substantial gain. It is very high risk and involves the anticipation of a swift rise in price so that one might sell the asset for a big profit.
For me, the difference between speculation and investing is long-term value creation.
To invest is to participate in the creation of long-term value. To speculate is to hope for a brief price aberration and score a big payday, with no concern about the creation of any long-term value but one’s own.
With gambling, it is nearly impossible to win over the long-term. With careful investing, you are likely to win (though that’s never guaranteed). Speculation lies somewhere in between…a lot closer to the gambling end of the spectrum, in my opinion.
Please don’t speculate in hopes of making serious money. It is highly unlikely you will. Creating reliable, long-term wealth is the role of investing, not speculation.
If you want to short stocks like GameStop, you’d be wise to anticipate your chances of success about the same as going to a casino.
And at the casino, at least they’ll let you eat at the big buffet.
Have other questions about financial matters? Here’s your last chance to get my free e-book, “The Three Financial Questions You Should Be Asking for 2021.” Email me at firstname.lastname@example.org, and I’ll send you a copy right away.
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