Saturday, March 21, 2009

Speculation Makes the World Go Around

Place your bets!
Is it a good time to buy stocks? What about distressed real estate? Blue chips are down and financials are dirt cheap - time to buy?

This is the fun world of speculation. We don't know what the future holds but are willing to place a directional bet. So what is wrong with that notion? Isn't all investing betting at some level? After all who knows what the future holds and what will pay dividends in the long term.

Yes - no one knows the future but you can reduce your risk (and increase your return) by betting on what has a high probability of success. Is the probability high that large corporations like IBM, Caterpillar and GE will still be around in five years and handsomely reward their investors? Is the probability high that you can accurately predict the price of gold five years from now?

In the first case your probability is high that you will come out ahead. Your risk is limited and your reward will be limited to reasonable returns. In the second case the probability of being right is low and thereby your chances of hitting the jackpot are also low. You get lucky and get a big payoff or lose it all.

So the question is are you comfortable with small but predictable return or high but volatile return? Both have a place in your portfolio. Some component of your portfolio may be speculative, directional and/or high risk. And some portion of your portfolio may be more boring but predictable and less risky.

Focus on an allocation that suits your risk appetite, time horizon, financial needs and market savvy. Spread your bets and stick around to play for a while!

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