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A Fascination with Speculation? By Stephen J. Butler

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Back in the 1300s, when Italian city-states were often at war with one another, battle tactics included the use of catapults to hurl plague-infested dead donkeys over the walls of a besieged city. Imagine the horror of looking up from the streets of, say, San Gimignano to see furry bundles of toxic waste whistling through the air like incoming mortars.

About the same time, the securities industry as we know it today was born to meet the needs of those city-states. Their rulers floated bond issues to finance their growth and defense budgets.

The past year's financial markets offered something similar to this medieval scenario. We catapulted technology stocks to ridiculously high price earnings ratios -- only to have them plummet and lose 90% or more of their value. "Toxic waste" is, in fact, the term used on Wall Street for these stocks.

To some extent, anyone invested in the market was caught up in the techno-euphoria of the past several years. Even an investor owning solely an S&P 500 Index fund was benefiting from the fact that roughly 30% of the largest 500 companies are technology-based. Yahoo, remember, was inducted into the fold as company number 500.

The boom and bust of the past five years offers a valuable laboratory for introspection. Now is a time to think about how we behaved from the mid '90's through 2000 and to ask ourselves if we have been gambling, speculating, or investing. If we conclude that we would have done some things differently, that may set the stage for a more satisfactory result during the next stock market cycle.

Let's face it -- gambling and speculating are fun. Both are attempts to increase wealth dramatically. Gambling actually creates a risk, while speculating usually involves taking over an existing risk. Not that it makes much difference. Compulsive gambling is a sickness in parts of our society, and speculating may be just a more sophisticated expression of the disease.

Investing, on the other hand, is an attempt to generate ongoing income and to protect against the downside. It is less concerned with trading assets than with owning and nurturing them.

We're better off as investors, rather than speculators, when managing retirement assets. However, it is difficult to resist being part of the mass movement into, say, fiber optic stocks when everyone else seems to be making a fortune.

So, how much of our financial decision-making is an effort to assure a long-term positive result, and how much is entertainment and stimulation?

It may help to know that we are genetically programmed to enjoy the hunt for the "ten bagger." This was the term used by Peter Lynch, manager of Fidelity's Magellan Fund during its glory years, when he bought a stock that increased tenfold in value in a year. Imagine investing your entire retirement account in a single stock that increases 10X within twelve months.

In 1841, Charles Mackay wrote a book ("Extraordinary Popular Delusions and the Madness of Crowds") in which he described how societies succumb to delusions and mass madness. He wrote about the Tulip Mania in Holland and other speculative frenzies. He concluded, "Men think in herds…go mad in herds…(and) recover their senses slowly, and one by one."

Women, not to be spared, have a history of even more rabid inclinations to speculate, but their patience and fortitude make them better equipped for success. In an era where they were discouraged from working and lacked the right to own land, speculation offered women an opportunity to create financial freedom. The Duchess of Marlboro, Winston Churchill's ancestor who created a family fortune through successful speculation, had what Churchill once termed "almost repellent common sense."

Looking back on my own investment experience of the past several years, I am reminded of the Los Angeles man who filled some balloons with helium, tied them to his aluminum chaise lounge, armed himself with a pellet gun, and cut himself loose to rise swiftly up into the commercial airspace above LA. His plan was to shoot the balloons on an "as needed" basis until his vehicle settled slowly back to the ground. For whatever reason, he couldn't bear to shoot any of the balloons and just kept going higher until pilots in the landing pattern for the LA airport reported him. He was rescued eventually in a daring maneuver conducted by a helicopter with a very long rope ladder.

I owned a few stocks and mutual funds that I couldn't bear to shoot down. In one example, I had a five-fold gain on a stock that is now worth one-third what I paid for it. I simply liked the stock too much to sell it, and I still do. Unfortunately, as they say, the stock doesn't know I own it, so my love is, for the moment, unrequited.

Nevertheless, my recent experience has taught me that not all of my investment decisions have been coldly rational. They should be. Entertainment and wishful thinking have no place in a cohesive retirement investment strategy.

To learn more about the fascinating subject of mass psychology - and to gain insight into your own financial thought process - there's a great book entitled "Devil Take the Hindmost: A History of Financial Speculation" by Edward Chancellor. It is an excellent account of the speculation waves through history and helps to put our own recent bubble into sharper perspective.

BUYandHOLD does not offer or provide any investment advice or opinion regarding the nature, potential, value, suitability or profitability of any particular security, portfolio of securities, transaction or investment strategy. Any investment decisions you make will be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance, and liquidity needs. The securities mentioned above are being used for illustrative purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy and past performance is no guarantee of future results.