Dear Nicole Speculating or Investing By by fionan


									Speculating or Investing
By Malcolm Good

I read with great interest the results of a recent stock market ‘investment competition’. In
particular, my eyes widened when I read that the winners had managed to make a fantastic
134% return on their initial investment, with the report noting that over the same period the
FTSE 100 had actually lost 3.20% – wow - all very impressive stuff!

So had the winning team cracked the secret to the stock market, had they found the holy grail
of investing? Sadly, I doubt it.

My concern was the time-scale of the competition which was held over an eight month period
to June ’09. For my liking, far too short a time period for anyone to invest in the stock market,
speculate: yes, invest: no. Not that there is anything wrong with speculating if that is what
someone wants to do, although I suspect many people who follow that approach do not
consider the potential risks that they are taking.

As I delved into the results for each of the 48 competing teams I was not surprised to see a
spread of returns. The chart below shows the % return for each team in the competition.

While the winning team managed to provide a great return (that’s its line to the extreme left),
two teams managed to pretty much lose the lot, with the last placed team retaining the
princely sum of 74 pence from its original £1,500.

However, it would be interesting to see if the leading teams could sustain their performance
over an extended period. Indeed, I am always nervous when I see fund managers highlighting
strong performance over six months or a year– why not over five, ten or 25 years, the length
of time that many people invest savings for their retirement? I think the answer to that
question is simply that it is very difficult, if not impossible, to find a manager who can
consistently beat market returns over the longer-term (it sometimes appears to be the case
that short-term gains or losses in the stock-market can be more down to chance than good

Thus, due to the competitions short time scales and from picking a limited number of shares
the teams were likely to increase greatly the volatility and associated risk of their returns.

For me, a canny investor may try to diversify out individual stock risk by buying a wide range
of shares and then hold them over the long-term. Indeed, much research shows that through
diversifying widely by type of share and geographic location greater long-term returns may be
achievable. Such an approach is sometimes referred to as ‘passive investing’ where index or
tracker style funds can be used to replicate market movements.
In addition, by holding and not trading shares, dealing and other costs associated with ‘active’
management are avoided as are the great difficulties in trying to time trades in the market.
Traders often miss-judge market movements and lose potential value.

However, I realise that setting up a competition where teams buy a fully diversified portfolio
that matches their attitude to risk and then hold on to it for an extended number of years
would make for a pretty boring competition.

So, while I congratulate the winners and think that they should be justifiably pleased with their
results, I wouldn’t be too disheartened if I was part of the last placed team as the results may
have been more influenced by timing and chance than they perhaps realise.

Malcolm Good is a Director of Melville Hutchison Financial Management and is the author of
Self-Help for the 21 Century.

To top