Gambling, Speculation and High Risk Investments

Here are two quick stories of people I knew well.

“Jim” (not his real name) was a close friend of our family. He was a very bright young man from a well-off family. Jim was sharp, persuasive and passionate. Unfortunately, his life didn’t work out for him at all.

Jim missed out on opportunities that should have worked for him. Then he found what seemed to be an easier way. His college instructor introduced Jim to a sure-fire mathematical system to win big money at gambling.

Before long, Jim had lent his new friend all of his money for their mutual gambling experiments. Soon, he had also used up all of his credit cards. He borrowed heavily from his friends, giving every reason but the true one. As he lost the trust of his friends, Jim sank deeper into debt and depression. Getting lucky at the gambling table seemed the only solution to him. Finally, after borrowing money from loan sharks, who beat him up, Jim chose to kill himself with a drug overdose, at the age of 22.

Second story: another young man I know well (“Sam”) inherited lots of money. Sam had an Ivy League college degree. He had several fine cars and spent his money freely. One day, Sam discovered the excitement of day trading. Although he told wonderful stories about his success, he lost everything when the NASDAQ high-tech market collapsed in early 2000. To his surprise, when Sam was broke, he couldn’t even find work at minimum wages because he lacked any recent job history.

What these two tragic young men shared was a mistaken belief that there is a quick, easy way to get rich. Jim and Sam sincerely believed that because they were quite intelligent, they would have the skill (and luck) to make it big outside the mundane world of hard work and patience.

They are not alone. When I watch people gamble away their hard-earned money in risky investments, I cringe. I feel sick in my stomach. It is like watching an approaching collision from a distance, with no way to stop the inevitable wreck.

This kind of irrational behaviour is not confined to the young and inexperienced. I have known many senior citizens, successful business people, and intelligent professionals behaving in a similar fashion and losing their money ever so quickly. Many have done it by simply following the advice of their stock broker or investment adviser.

Let me suggest a few rules to avoid tragic investment losses:

• Any investment that sounds quick and easy is likely to fail quickly.
  
  
• If someone parades impressive credentials or uses complex arguments in trying to sell you an investment, avoid it like the plague. I once invested a in a high tech company because its very distinguished chairman persuaded me that the company had enormous potential, even though I didn’t really understand his business. Within a month, the company was bankrupt.
  
  
• Don’t ever put all or most of your eggs in one basket. Spread out your investments into many parts, so that if one of them fails, you won’t suffer a catastrophe. Stock market indexes and mutual funds provide more diversification of risk than any individual stocks.
  
  
• Don’t expect to make large returns. Warren Buffett, perhaps the greatest American investor, warns against looking for returns greater than 6% to 8%. You may sometimes get lucky with a sound investment when the market is strong and make 15 – 20% on your whole portfolio for a year or two. But those instances will be offset in the longer run by investments that lose money in a bad economy, like the one unfolding at this moment. Long term investment returns rarely average above 10% for even the best people in the investment business.
  
  
• Avoid start-up companies, companies that are claiming a quick turn around, and/or innovative technical concepts which you don’t fully understand. At most, I would put a fraction of 1% of my money in that kind of situation, even if it sounded absolutely wonderful. Statistics don’t favor these kinds of investments.
  
  
• Avoid any investment which claims there are no risks involved. Even US Government bonds and bank deposits have some risk. Most investments have far greater risks; if you can’t see what these risks might be, you don’t understand them yet.
  
  
• Avoid any investments proposals made through the internet, from ads coming in the mail, or by telephone solicitation. They are hard to check out thoroughly.
  
  
• Also, avoid investments recommended to you by your friends. It is too tough to remain objective.
  
  
• All investments, whether in stocks, commodities and bonds can sometimes go down sharply. I have never met anyone yet, even a billionaire, who doesn’t lose money on some of their investment picks. They are lying if they tell you otherwise.
  
  
• Keep most of your money in the bank or in government bonds unless you can afford to take big losses. In the current economy, some of the world’s largest companies are seeing declines of their stocks of 10%, 20% or even 30% within a few months time period. If you believe that you can always tell the good stocks from the bad ones, I would like to recommend psychiatric help for you!
  
  

Gambling is a vice to be avoided, especially gambling with your precious savings on stock market or other investments. Investment is a humbling and risky business. To have long term success you will need to spread out your investments among very well proven assets. Trying to get rich quick is a path to financial disaster. Sound investing is mostly dull.

Postscript

My gloomy outlook on the world economy and financial markets (as expressed in my blogs during the past 18 months) is proving out to be correct. For what it is worth, I believe we are at least one or two years away from the bottom of this massive downturn. Beware!