Speculators take big risks with the potential for big gains over a relatively short time period. They are generally sophisticated investors or traders with experience and expertise in the market in which they are trading. Speculators often try to predict price movements of an asset and may utilize leverage and other techniques to increase the potential gains while also increasing the potential losses.
The danger of this approach for a typical individual investor should be obvious. Few people have the expertise, time, and available resources to take large risks for quick gains. And even the experts often fail. Early on in the recent market volatility, the biggest losers were professional fund managers who took positions betting against the stocks increasing in price, with losses totaling billions of dollars.2 On the other hand, the prices of high-flying stocks — without underlying value to support them — could fall back to earth as quickly as they rose, leaving many small investors with painful losses.
Another legendary investor, Bernard Baruch, cautioned: “Don’t try to buy at the bottom and sell at the top. It can’t be done except by liars.”3That may be an exaggeration — some speculators do have success — but it captures the risk of trying to time the market.
A long-term approach
Investors also take risks, of course, and they certainly pursue gains. But unlike speculators, investors are generally committed to a long-term strategy based on sound investment principles. A smart investor buys assets that appear to be good investments and then builds them into a balanced portfolio that is appropriate for the investor’s goals, time frame, risk tolerance, and resources.
Of course, having a balanced portfolio — using strategies such as asset allocation and diversification — does not guarantee a profit or protect against investment loss. However this approach is an established method to help manage investment risk. It may enable you to take advantage of market upswings while helping to control losses during downswings.
Cool your jets
Along with managing risk, an investor should manage his or her own emotions and expectations. That can be difficult in any market situation. When the market is rising, for example, it may be tempting to rush into the current “hot” investment and buy at a high price. And when the market is declining, it can be tempting to sell near the bottom. Even when the market is flat, you might feel that you have to do “something” just to keep your investments in motion.
If you have a well-constructed portfolio, one action you might take in almost any market situation is to make additional purchases in your investment account(s) — although the market could influence how you allocate your investments. Other than that, the most appropriate strategy may be to do nothing and let your investments pursue growth through long-term market trends.
Paul Samuelson, who won the 1970 Nobel Prize in Economic Sciences, described this approach in humorous terms: “Investing should be more like watching paint dry or watching grass grow.”4 A patient investment strategy, often called “buy and hold,” may not be as exciting as speculating, but it will probably serve you better in the long run.
All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost.