Tuesday, November 11, 2008

A solid definition of investing

There were some good answers to yesterday's question about investing that showed at least people reading the blog have given the subject some thought. Too bad more people either weren't reading or commenting!

Either way, here's my definition: I think investing is any activity that involves the carefully considered allocation of your resources with the goal of appreciation over the long-term.

A few important points: Note I said "carefully considered". This is one of the biggest ways that investing differs from say, casino gambling or its close cousin, day-trading. Investing is strategic and is not done without planning for your goals and how much money or time you have to devote to them. If you're just pouring money into the market with the ONLY goal to have more money tomorrow, you're leaning more toward gambling than investing.

Also note that I said "resources" and not just money. On this blog, of course, the resource I talk about is money but there are many other resources with which to invest. Time is probably the most important one. If you're taking time out of your day to read this blog, you're making an investment in gleaning what you can about personal finance from my observations. You can invest in your education, your home, your children. The point is you're devoting a resource that's limited (time or money), which makes it valuable, and in exchange you expect an output worth more than what you put in.

My final point is that in most cases, investing is done over the long term. There's a commercial for one of the big brokerages that shows two runners: one is slow and steady, while another guy speeds past him. By the end of the commercial they've gone a few miles and you see the fast guy bent over, tired as hell, unable to make it over a big hill. Slow guy passes him.

Get the point? For most investors the point isn't getting rich fast. It's watching your capital appreciate over the long-term through steady, consistent practices. Too often those who are in a rush to make a bunch of money end up losing, like the runner who can't make it over the hill or the day-trader who's kicking himself right now for going long in mortgage-backed securities. Those who win are the ones who keep making the same contributions to their 401(k) plans for decades, making only the necessary adjustments and not worrying about temporary fluctuations in the market.

So now that you've read my definition of investing, has your opinion changed? is there anything you'd add or that you disagree with?

Coming later: Two pledges you should take and why Barack Obama should build trains.


Product Junkie Diva said...

Great definition. thanks

Sanglucci said...

Good definition Keith but what would you say to the investor, who practiced those exact principles which you've described here, and lost all of the money he accumulated over the years because of a manipulated housing industry. That problem breached through every industry and every country and caused "investors" and 401K holders to go bananas. And let's face it with an "investing" strategy, those people never put their money into cash and are now sitting through this mess still contributing and waiting for the market to go back up. For those who are ready to retire what do you say to them when it's time for them to cash out and they don't even have half of what they had when the bull market came around. What you're saying about investing definitely holds a lot of value that is the true meaning but those "temporary fluctuations" you're saying 401K investors shouldn't worry about? What about the shit that's going down now? This is a temporary fluctuation? We're back to lows of 2002 2004. HOWEVER, the fundamental concept of carefully allocating your resources so as to appreciate over the long term is still intact. But you gotta admit man, nobody saw this coming and that financial brokerage commercial you talking about... Merrill Lynch's and Lehman Brothers commercials were all about catering to the smart investor the one who carefully planned out his actions... Meanwhile those guys were doing what... playing the market to make money and investing chunks in the housing industry... So you gotta admit man there's some funky shit people gotta be aware of.

Keith T. Reed said...

Sanglucci, you're right. There are many pitfalls that both average Joes and experienced investors must watch out for. But I think some of what you said is a little contradictory.

The housing bust, I think, is a perfect example of a situation where more careful, prudent decision-making would have made all the difference. Instead greed, by both Wall Street and consumers, got in the way. People who are losing value in their homes but who made smart decisions (like only buying what they could afford and saving for a down payment) are tragically the collateral damage done by Wall Street types who bet on subprime mortgages and credit default swaps, and also of their next-door neighbors who thought it made sense to buy a $300,000 house on a $50,000 income.

The difference is the prudent homeowner will take a hit, but will likely be able to weather the storm and keep his or her home (provided their job doesn't go away). The other guy won't. And that's the point: every investment you make carries risk, but there are ways to mitigate that risk. Investing for the long-term and being smart about your decisions helps you weather storms like this one.

And yes, what's happened in the stock marker the past few months is a temporary fluctuation and should be treated as such. I understand that many people are worried about their 401(k)s, but as I've said many times: panic will hurt more people than prudence. The market will ultimately rebound and those who are young enough can weather the storm. If you're nearing retirement and have lost much of what you saved, that's is indeed a tragedy but it's also where planning and education come in: a basic rule of long-term investing is that the closer you get to the finish line, the more conservative you become. No one nearing retirement should be mostly in stocks, and if they had already made the proper adjustments when the storm came, they'd likely be fine.