One of the big lessons Ben Graham taught in The Intelligent Investor was the difference between investing and speculating. He knew how easily the market distracts investors from their original purpose.
Most investors start off with the idea of compounding their money over a long period of time. But some of them are bound to get sidetracked.
Before they know it, some investors start feeding their impulses triggered by Mr. Market’s manic moods. Their emotions take over. Stocks become pieces of paper, rather than portions of a business, to trade in and out of. Price moves become the only factor behind their decisions.
Seth Klarman used a funny analogy in his book Margin of Safety to describe this mistake. He tells the story of special sardines.
There is an old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, “You don’t understand. These are not eating sardines, they are trading sardines.”
Like sardine traders, many financial market participants are attracted to speculation, never bothering to taste the sardines they are trading. Speculation offers the prospect of instant gratification; why get rich slowly if you can get rich quickly? Moreover, speculation involves going along with the crowd, not against it. There is comfort in consensus; those in the majority gain confidence from their very number.
Today many financial-market participants, knowingly or unknowingly, have become speculators. They may not even realize that they are playing a “greater-fool game,” buying overvalued securities and expecting — hoping — to find someone, a greater fool, to buy from them at a still higher price.
There is great allure to treating stocks as pieces of paper that you trade. Viewing stocks this way requires neither rigorous analysis nor knowledge of the underlying businesses. Moreover, trading in and of itself can be exciting and, as long as the market is rising, lucrative. But essentially it is speculating, not investing. You may find a buyer at a higher price — a greater fool — or you may not, in which case you yourself are the greater fool.
It’s a fitting reminder of the risk that comes with ignoring value, succumbing to instant gratification, and attempting to pull off decades of compounding in a matter of months. Trying to get rich quickly in the stock market is more likely to leave you poorer…and with a horrible taste in your mouth.
Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor
- The Price of Risk! – Musings on Markets
- Investing in a Bubble – Verdad
- Why Bubbles Are Good For Innovation – A Wealth of Common Sense
- Pitfalls of the Inflation Narrative – Klement on Investing
- How to Be Lucky – Psyche
- Why You Should Practice Failure – Farnam Street
- “Hard Times Tokens” Were Not One Cent – Daily JSTOR
- The Secret Letters of History’s First-Known Businesswomen – BBC