Monthly Archives: September 2010

The Difference between Investment & Speculation

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Investment is the low to medium risk art of conserving capital and protecting it against inflation, such that in the long run, capital appreciates. Speculation is the high risk art of trying to turn a small amount of money into a large amount.

Investment banks upon the power of compounding. It is an amalgamation of human, monetary and product capital, a combination that favours appreciation in the long run, not linear, but exponential appreciation, owing to the power of compounding. The key requirements are intelligence during scrip selection, patience and tolerance to allow multi-baggers to develop and blossom, and common-sense in handling one’s portfolio. Also, one needs to weed one’s portfolio at times, to remove poisonous scrips.

Speculation banks upon the power of leverage. This construct of finance is a double-edged sword. It can compound one’s profits, but also one’s losses. The speculator tries to cut losses and let profits run. This is easier said than done, because it goes against our natural instincts.

In the end, there are both successful and unsuccessful investors and speculators.

The key to deciding what line one should pursue here is a recognition of one’s own risk profile and appetite. What gives one sleepless nights? What is one’s pain threshold? How much loss can one bear without any effect on family life?

Such questions need to be answered before embarking upon either investment or speculation.

The How, What and When of Equity

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-> Open a demat account and link it to your savings account online.

-> Open a trading account and link it to your demat account.

-> Don’t go in for a brokerage house, but for a trinity account with a good bank, like HDFC.

-> Try and press your relationship manager for a commission of 0.25% (+ STT + Surcharge) or less.

-> Put some money aside each month, and purchase upon opportunity.

This is the “how” of Equity.

-> Buy scrips of companies with good managements, innovative products and promising futures.

This is the “what” of Equity.

-> Buy when a scrip is at least 50% off its highs.

-> Sell if a scrip in the long run doesn’t show signs of turning into a multi-bagger.

-> This way, over 20 odd years or so, you’ll accumulate a basket of multi-baggers.

-> Sell a multi-bagger only when it shows signs of an impending big collapse.

This is the “when” of Equity.

An Important Case for Equity

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There’s something that bites away at one’s money.

It’s called inflation. And, over the last 100 years, it’s been around on a habitual basis, a virus that needs attending to.

This virus attacks one’s purchasing power. If one doesn’t take any immunity measures, or if a particular country has an unsound economic policy, the disease caused by the virus is called hyperinflation, a cause for wars and economic collapses.

So, how does one immunize oneself? One example is through the purchase of Equity. Of course I’m talking about the long-term perspective during such a purchase, because that’s when this strategy will hold, over a 5-10 year period or more.

When a buyer bids for equity, he or she makes an automatically inflation adjusted bid. The bid will or will not be met as per the ruling demand and supply equation. This demand and supply equation can only balance itself after adjusting for inflation.

Thus, the buying, holding and selling of equity, over the long run, will take inflation out of the equation.

So, if one holds the bulk of one’s worth in Equity over let’s say a period of 50 years, just do the Math and see how much value one saves if the average rate of inflation is taken to be around 5-6% per annum.

This is definitely a clinching case for long-term Equity.