A Nigerian Prince
Have you ever been scammed?
Since the birth of the internet, we, the American people, have become quite familiar with scams. We now know to delete any proposal for a financial exchange coming from a Nigerian prince.
We dodge these scamming attempts daily. Yet, these scams are still in high production. Why? Unfortunately, because they still work, people are still being duped daily.
These scams try to lure you in with a request for a small commitment in exchange for a big reward. Maybe a better way to say this, people are tempted by the opportunity to get something for nothing.
These Are Not Investors…
We know that in the real world, wealth is accumulated via hard work, innovation, and, typically, patience. Yet, stumbling upon free money – that winning lotto ticket – is still captivating for many.
Some people say the stock market is a scam. To be clear, it’s not, but what do they mean by this? Most likely, they’ve had an experience in the stock market that felt similar to a scam. They aspired to turn $1 into $2 and were disappointed when the outcome didn’t match their expectations.
The problem is that these folks weren’t investing; they were speculating. It’s so incredibly important to (1) understand the difference and (2) be clear on what you are personally doing – investing or speculating.
When Timing is Everything
Have you ever played the game of hot potato? To win this game, you simply have to avoid having the potato in your hand when the music stops. You are fine to hold that potato danger-free as long as the music is playing, but when the silence hits, you need to be empty-handed.
A game of hot potato is a lot like speculating, and I can see how that could feel like a scam. When one is speculating, they are not anchoring the price of an asset on a fundamental metric. The rise in price is not related to the rise in profits but rather the rise in popularity. So, the key to speculation success is to foreknow when that music will stop, when that popularity will dip. An impossible endeavor, no? Hence, those who’ve fiddled with speculation have met disappointment face-to-face and concluded that markets are a scam.
The Principals of True Investing
On the other hand, Benjamin Graham, Warren Buffett’s famed professor, described true investing this way, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” Said another way, investing depends less on popularity and more on the improving underlying financial metrics of a functioning business.
Investing can be boring and can take a great deal of patience. There isn’t really a get-something-for-nothing opportunity when it comes to true investing. Investors know how long and difficult it was/is to build wealth, so they are intentional about being prudent to protect and grow that wealth.
It’s Human Nature
Lately, I’ve seen a big uptick in multi-level marketing (MLM) entrepreneurial enthusiasm. Friends, friends of friends, or friends on social media who really aren’t friends, have been posting nonstop about the different MLM ventures and opportunities they are participating in. Whether that be oils, shampoos, or makeup lines. The promotional hype seems to be more about the paychecks (or the potential for a paycheck) than the business itself. The passion is about making money, not the quality of the product.
Again, the same truth applies here. If the hype can drive popularity and engagement, there is little need for process or fundamentals. Yet, these fads come and go, and many friendship and familial relationships have been destroyed on the topic of multi-level marketing. The popular MML brands and schemes we’ve become familiar with now get the same reaction as the Nigerian prince.
So, why are we so prone to these traps of speculation? It’s human nature, I suppose. Just like fish chasing bait, the food looks tempting, attractive, and ripe for the taking. This is the lure of speculation.
What Drives Returns
It’s always good to remind ourselves where stock returns actually come from. I am going to offer you a very simplified answer. Stock returns are the summation of the dividend paid, the growth of earnings, and the change in the multiple. These first two variables are quantitative and can be derived from studying and understanding the company’s financials. The last variable – changes in the multiple – is a very qualitative metric. The overall sentiment (popularity) surrounding a company can drive that multiple (the stock price relative to the profits) beyond what is fathomable or even reasonable.
Investors depend on improving earnings and dividends; speculators depend on improving multiples. Just like emotions – fear and greed – are prone to be volatile, the expansion and contraction of multiples can be violent and financially destructive. Aggressive multiple contraction, a surprise plummet in a stocks price, can leave one feeling like they got scammed.
No FOMO
So far this year, my personal portfolio is up less than 10%, while the Nasdaq is up north of 35%. Is this upsetting to me? No, not one bit. Perhaps a bit of jealousy? Regret? Fear of missing out? No, ma’am. I am cool as a cucumber. Why so? Because the price of the Nasdaq is the same today as it was back in June of 2021. That is 27 months of go-no-where markets in an index with a reputation for excessive speculation. An index [the Nasdaq] that spent the start of this millennium underwater for over a decade.
Speculators who think they are investors will often feel like they were scammed, and they will falsely conclude that the stock market is a scam. Whether it’s hot potato or musical chairs – a game where timing is everything – ones luck is bound to expire. Speculators are doomed with the same fate when depending on luck and perfect timing.
Moral of the story, your financial plan should depend on an investment strategy that is seeped in process, not luck. This process should focus on growing profits over growing popularity. And, lastly, you must fight the urge to take that bait that lures you into the mirage of easy money. On the road to wealth accumulation, there are no shortcuts.
