The single biggest challenge to investors: the three faces of investing
Couple of months ago I was invited by TD Direct Investing to take part in a debate on investor confidence. Of course, I accepted; after all following our hunter’s focus on debt our sight has moved to investing. Having said that, we do believe that the principles of sound money management are the very similar irrespective of whether one is paying off debt or investing – in both cases you build wealth. But I seem to be digressing a bit.
We had a debate and we recorded a video; here is the link to the video but I’d rather you don’t watch it; or at least if you decide to watch the debate (it is rather long, I warn you) please do close your eyes so you don’t get destructed by the way I look. Just listen to the smart things I have to say (this is a joke btw).
One of the questions we were asked during the debate was:
What is the single biggest challenge for investors?
On camera my answer was short and succinct:
The single biggest challenge investors currently face is the volatility of the markets.
So far there is nothing interesting and/or original about this but bare with me: the interesting part is in the reasons why I think that this is the single biggest challenge to investors.
I believe that volatility is such a challenge because it changes the relationship between the three faces of investing, namely science, art and gaming. Investing has always been, or has been presented, as a unique combination between the three; it also requires an unique blend of knowledge, intuition and awareness of risk and probability.
Probably the best example of investing as science is provided by the Boggleheads’ philosophy: this is all about well informed choice. It may be choice of lifestyle, choice of investment instruments etc. Interestingly, approaching investment as science and research features both a particular stage of learning about it and specific investment instruments. I believe that research is absolutely essential to be able to choose risky stock to buy; and that this research should be rather broad (learn most there is to know about the product, the company, the key people in the company and the others who have similar product).
Next, is investment as an art form. This, I believe, kicks in when one is shaping and re-shaping their portfolio – what investment portfolios look like is not a matter of science and research but of feeling and balance.
The aspect of investment that fascinates me most is the gaming part of it. This applies to specific investment instruments like some options, exchange-traded funds (ETFs), CFD trading (Contract for difference) and different forms of financial spread betting. These are all rather speculative investments. CFD trading, for instance, is an equity derivative used by traders (investors) to speculate on the share price of particular shares without actually holding any of these shares; the contract between the two parties is about paying the difference between the current price of the share and its value within certain time frame. High risk but can be potentially very rewarding.
A less discussed aspect of investing as gaming is the gamble that one necessarily takes. Different investments carry different level of risk, true. But because of the level of complexity of financial markets and the stock market, there is always an element of risk we have no awareness or control over, risk that can’t be calculated.
In relatively stable markets these three elements mostly coexist and if any of them took a bit of precedence these was the scientific, predictable and ‘safe’ element.
The situation is somewhat different in volatile, fast changing markets. In such cases the face of investing that can become dominant is the gaming/gambling one. It is no longer possible to present investing as scientific and/or artful activity with mostly predictable and positive outcome.
At the moment investing in the stock market is to a large degree a gamble; and as every half competent gambler knows you take to the table only what you really can afford to lose.
It seems to me that making the transition from seeing the stock market as a viable long-term investment prospect to viewing it as potentially expensive game is a challenge. Another challenge is to workout alternative investment strategies.
What do you think is the single biggest challenge to investors?