THERE'S SOMETHING ABOUT
having money that makes people do incredibly foolish things with it.
Think of it as the investment version of the "wealth effect": Uncomfortable with savings and hesitant to sit on cash, many people insist on putting 100% of their assets to work, and not a penny less. This constant need to be invested prompts them to make investment decisions for exactly the wrong reasons.
Without a doubt, the most idiotic reason to make an investment is for fun. Whenever I hear people draw a distinction between their investments and their "fun money," I can't help but feel a bit nauseated.
No matter if you've got millions or just a few grand, the fun of investing is making money. Putting assets to work for giggles or amusement is akin to throwing cash down the drain. Why do it?
For some strange reason, people find great pleasure in owning a lot of anything even a worthless piece of stock. That's why fun investments are oftentimes bulletin-board plays, which, as we wrote a few months back, are almost always doomed from the start. In this case, the fun comes from the fantasy that some obscure pump and dump on the pink sheets might actually jump from pennies to dollars. Trust me because I know 99.99% of the time, it's a losing, and therefore a decidedly un-fun, endeavor.
Sometimes fun investment comes from the impulse to "buy what you know," a rotten investment technique based on nothing more than coincidence and luck. Although many people undoubtedly bought Tivo because they loved the product, or stocked up on Pfizer because Viagra changed their lives, I go back to our oft-mentioned point that a company and its stock are two different entities altogether. It's OK to love a company but not buy its stock. There's nothing fun about buying a stock that declines no matter how grand the company might be.
Many companies hand out freebies to investors, such as discounts or coupons, as an incentive to continue holding onto shares. Kimberley-Clark, for example, sends shareholders free toilet paper and paper towels. Wrigley sends out complimentary gum. AT&T sends shareholders free 10-minute calling cards and Starbucks holders get a coupon for a free coffee. And while the giveaways are a novel perk, to make an investment decision based on them is absurd. People will lose thousands of dollars in investment capital just for the fun of getting a coupon for razors from Gillette. It just doesn't make sense.
Ironically, the biggest problem with fun investments isn't their performance, but their allocations. Because we segregate certain investments as serious and others as fun, we tend to take much smaller positions in the latter. This inconsistent position sizing creates a highly inefficient use of capital. Inevitably, the safe "legitimate" picks underperform, but the longshot fun stock zooms. Because the investor has taken such a meaninglessly small position, the move has no effect on his bottom line.
I don't live for the "high" that comes with being exposed to risk. The joy of investment comes from being successful at it, not simply experiencing the thrill of setting hard-earned money ablaze. Having fun is an important part of life but not of an investment program.
Many investors make decisions through the lens of what's known as socially responsible investing. In this increasingly popular field, investments are screened not only for their profit potential, but also for any number of social issues like environmental friendliness, hiring practices and adherence to religious values. Although there are many private money mangers that specialize in socially responsible investing, most individual investors interested in doing their good deed opt for one of the many socially responsible mutual funds now available.
The Enterprise Global Socially Responsive Fund, for example, describes on its Web site how its process attempts to "screen out the bad." To be avoided are the fund's so-called "sin stocks," which include "alcohol, tobacco, gambling, weapons, nuclear power and negative practices, such as discriminatory labor practices, animal testing and environmental violations." For my money, that's a downright asinine method that prompts many investments to be made for the wrong reason.
Capitalism is a social system that protects individual rights. So while I certainly respect people's rights to invest as they see fit, I find the notion that law-abiding companies could somehow be "irresponsible" bizarre.
If a company produces goods or services that others see value in supporting, that's all I need to know. In a free country, there's nothing more responsible or noble than mutually beneficial trade.
To avoid a company's shares simply because it deals in sexual material is ludicrous. If responsible adults choose to perform in, consume and profit from pornography, there's nothing the least bit irresponsible about considering those companies as investments. From Private Media to Rick's Cabaret, the free market will decide if the enterprises rise or fall. I happen to think Playboy is a national treasure (and in the last few weeks, a fairly buoyant stock).
The same goes for gambling, a perfectly legal pastime that millions of adults approach in a responsible manner. Although I don't much enjoy the tables or slots myself, I salute any lawful company aiming to produce an even better gambling experience for its customers. If someone wants to spend a great weekend drinking, cavorting and gambling in Vegas, here's to him, and here's to the companies like Harrah's or Caesars that make it happen.
The biggest joke is that socially responsible funds consider weapons manufacturers and defense companies to be "irresponsible."
Personally, I don't curse the defense companies I thank God for them. Every day, on almost every news broadcast, we see just how vitally important their innovations are. Our advanced weaponry, night-vision technology and aeronautical expertise have saved thousands of American lives in the war on terror. To Lockheed Martin and Northrop Grumman, bravo.
APPLET PLACEHOLDER: archive= height=325 width=625
Data from Aug. 27, 2004 to Nov. 26, 2004
Source: Reuters Investor
More than any other factor, I think socially responsible investing puts people at a disadvantage in the market right from the start. It's hard enough to make money with the entire universe of investments at your disposal. To start eliminating companies simply because they offer same-sex-partner benefits or burn large amounts of fossil fuel is a foolhardy way to run money.
I don't believe a company is worthwhile simply because it has promoted a racial minority or shameful because it has not.
And should a company support gay rights, donate to MoveOn.org or plan on developing a new cigarette, shareholders should know about it but they shouldn't invest accordingly. The marketplace is where a company's products are evaluated. As a trader, my job is to watch its stock. End of story.
Some of the worst investment decisions are made on the basis of taxes, a fact of life many investors are loathe to deal with in a rational manner. What should influence a trading decision is the market, not tax law. While it makes sense to allocate those securities you expect to generate large taxable returns to sheltered accounts, making investment decisions based on tax considerations is foolish.
Yet I can't tell you how many times I've heard people say that while they'd like to sell a stock, they won't. Why? They don't want to pay the taxes. Of course, the money itself doesn't know if it's tax sheltered or not, and neither does the security in which the assets are invested.
What usually happens is that they end up waiting until the stock has dropped another 30%, at which time they end up selling the stock anyway and paying less in taxes on a much smaller gain.
It's the job of investors to generate> capital gains. Let the accountants figure out how to keep it from Uncle Sam. And while I also hate the idea of writing large checks to the IRS, as my late father used to say, "If you're paying taxes, you're making money." If you want to reduce your tax burden, change your elected officials, not your trading style.
In the final analysis, market decisions should be based on the market. To trade for fun, for tax considerations or to further a social agenda just confuses the point of the whole exercise: making money. For me, that's a worthy end unto itself.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, his fund did not own shares of any of the companies mentioned herein.>