Twenty Something Sense

Throughout this economic downturn I have read countless articles detailing people’s personal struggles that have been a result of substantial investment losses they’ve incurred. These articles all carry the same theme: “I am getting screwed by the MAN”. I have little sympathy for the small investor (read you and me) who makes fundamental investment mistakes and then places blame on the government and corporate big wigs for ruining their life.

Let’s use an example from Saturday morning’s WSJ to help me explain my stance and prevent YOU from making these all too common mistakes. There was an article about an 81-year-old retired teacher whose initial $40,000 “investment” in GM bonds five years ago is now worth less than one-fourth of it’s initial value. I hate that the article is written to draw sympathy for the small investor, which is evident by the following two published quotes from the retired teacher:

“The bondholders are not all rich. I need to conserve my assets.”

“I’m not doing the negotiating here, but why is the company doing this to me.”

Dear Teacher - You bought unsecured GM debt. When you made this purchase, you made a bet that GM would remain strong enough to be able to meet all of its interest obligations to you and that they would be able to return your original principal to you once the bonds reached maturity. Unfortunately for you, things haven’t exactly panned out as planned and GM is on an almost certain road to bankruptcy. You have lost your bet and you will at most see pennies on the dollar for the original $40,000 you bet on GM.

Why do I put such am emphasis on “bet”? It is to highlight a common problem that I see with the average investor - people always confuse investing with speculating. Let me share what I find is a good definition of investment from Benjamin Graham’s legendary book Security Analysis written in 1934:

An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.

I would say 99% of the mediums that we classify as “investments” are in fact merely speculatory plays. Buying unsecured debt or equity of a single company is placing a bet on the future prospects of that company and with all bets, there are risks, and in this case the risk of buying unsecured debt in GM, leaves our teacher friend out of luck.

Please, I beg of you, do not gamble your money away on speculative bets. The most important investment principal is diversification - always keep your money diversified.

*Note: I must clarify one thing. I am in fact empathetic for our teachers situation because I am almost certain that she did not purchase GM bonds all on her own. Most likely an investment advisor recommended these bonds to her and sold them as a “safe” investment. Financial advisers misleading and taking advantage of investors is a real problem in America and something that I will try to address in a future blog.