The difference between speculating and investing

speculating #TradeMyWayDuring my three years working for a stockbroking firm, I learned the difference between being an investor and being a speculator. During the time that I was responsible for setting up the retail trading desk, I saw firsthand the mistakes many private clients made when it came to trading.

Keep in mind that this was during the dot.com bubble in the late 90s and many companies that should probably never have been allowed to list, were doing so. Several of these companies no longer exist today. Despite the dubious nature of both their businesses and directors, their initial public offering (IPOs) were oversubscribed and on the day of listing the share price invariably leapt up by at least ten percent.

If you could get in on the listing, it was guaranteed money – not because the companies themselves were worth anywhere near what they were listing at, but because there was blind greed and someone out there would be prepared to buy it from you at a higher price for no rational reason except for hoping that the next person would pay even more. Sound familiar?

It got to a point where people were using the seven-day settlement period to buy and sell shares within seven days, hoping to make a profit before they even had to pay for those shares! Fortunately, I happened to work with a lot of grey-haired, experienced individuals who knew a bubble when they saw it. One of the smartest things our director did was to refuse to trade on a seven-day settlement unless the client had deposited money with us or had an existing share portfolio double the value of the trade.

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When the bubble burst spectacularly, both in the Russian financial crisis of 1998 and again with the dot.com bubble crash of 2000, our brokerage survived. Many did not because their clients were buying shares with money they didn’t have – they were simply speculating.

I was fortunate to work with people who taught me that the real power of investing comes not from the share price, but from dividends. The focus of the portfolios they managed for their clients was on providing dividend income which is far more predictable and stable than the capital growth of a share. Many of those hastily patched-together companies that were listed in the late 1990s could not generate legitimate earnings to pay a dividend, so were never included in the portfolios.

My mother’s portfolio was among those and I still remember when she called me one day and said, “I don’t understand, all my friends are complaining that they have lost all their money in the market but I am still getting my monthly income, how is that possible?” Not only did my mother continue to receive her income (which increases ahead of inflation each year thanks to the fact that on average JSE listed companies increase their dividends by around 8% per annum), her capital value also survived the crashes – and many more – because high-dividend stocks are by nature more defensive.

It was a great lesson to learn early in my investment career and it forms part of my investment philosophy which is best illustrated by my purchase of some Standard Bank shares in February 2016. I noticed that Standard Bank had a dividend yield of 7%;  this made no sense because if I put my money on deposit with the bank, I would receive only 5%. The high dividend yield suggested the share was seriously undervalued. I invested in it and within two months the share price was up 30%., which is great from a capital point of view, but even better, by buying at the lower price I locked in a 7% income return which has a lower tax rate than interest income.

Investing is about the long term and over time, it will serve you better than speculating on short-term market exuberance.

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