When I go through the investment process with clients, explaining risk and return to them, I sometimes get the throwaway comment “it’s just like gambling anyway”. I always have to correct them that investing is nothing like gambling at all.
When you gamble, you are betting on a particular event happening. You know what your potential returns are at the outset (they can be no higher than the odds you take) and there are two outcomes; you win that fixed amount of money or you lose all your money. There is a winner and a loser based around that one event happening. Your horse wins or loses that race, if it wins the next race, you get nothing unless you have bet on it again.
When you invest in a company, you become a part owner in that company. You will probably only have a tiny ownership but you are a part owner nonetheless. As an owner, you get to share if the company does well and likewise you have to shoulder some of the burden if the company doesn’t do well.
Take Disney for example. If they bring out a new Star Wars film and it does well in the box office as well as selling loads of merchandise, the value of the company will go up and so will your portion of ownership ie share price. If people don’t like the film and don’t go to see it or buy the merchandise, the value will go down and so will the value of ownership. The return you get isn’t fixed, it is what the market decides the value is.
But it doesn’t end there. As an owner of a going concern you participate in all the gains and losses of the company for as long as you own shares in it.
Then there’s speculation, Wolf of Wall Street stuff where you are putting your money into something in the hope that it’s going to make you massive returns. As risk and return are related, if you can make massive returns, you can also lose all your money.
Speculators tend to abandon the fundamentals of investing. Take those who invested heavily in Irish bank shares in 2008. The basis of their investment was no more than ‘their Irish banks, the won’t go bust and will come back’. Exactly 10 years ago, AIB was trading at €12.94 and Bank of Ireland at €8.10. Today they are worth €4.88 and €7.36 respectively.
As a financial planner, my job is to guide you throw the investment process, help you avoid speculation and put you in a position that you have enough money for the rest of your life. Investing in a diversified portfolio of global stocks is as boring as it sounds, but no one likes losing all their money either.
If you have any questions, send me an email at steven@bluewaterfp.ie