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Retirement Planning and Speculation July 24, 2008

Posted by retirementwithaplan in Uncategorized.
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This blog post originally appeared on another blog server on 01.06.08

What is Speculation?

Once you understand the way risk and reward operate – or better, how more risk might mean more reward, the tendency is to assume more risk is almost too tempting to avoid. This is often done, in many cases with the full knowledge that increased risk does not always result in increased reward. In other words, once you grasp the seductive power of increased risk, many investors choose to discount the downside of the equation. This can be incredibly dangerous when it comes to your retirement portfolio.

Consider the word speculation. Speculation (spek’yuh-LAY’shuhn) n. has several definitions. The first is the act of speculating or the contemplation of a profound nature, a conclusion, opinion, or theory reached by speculating. We think therefore we speculate.

The second definition is much more dangerous. It involves the engagement in risky business transactions on the chance of quick or considerable profit. Jacob Freifeld’s 1996 paper on the subject of behavioral decision making titled “Speculative Bubbles: Financial Genius Before the Fall” came well in advance of what was to be, at least until the sub-prime mortgage mess began to unfold recently, the greatest market bubble of in recent history.

He wrote about the theory of speculation: “In some cases this financial innovation is replaced by changes in government policy that either favor easy credit or lower taxation, stimulating rapid business growth. Whatever the case may be, a financial atmosphere of tremendous supply combined with demand for some desirable asset, be it stocks, real estate, or even rare tulips, gives birth to the speculative bubble.”

Speculating on the Tulip

Many financial writers, myself included have alluded to the lessons of the tulip. Tulips became the craze of the wealthy in the early 1600’s, so much so, that if a person of means did not own a collection of these rare flowers, they were considered uncultured. The demand for these exotic bulbs grew into speculative and historic proportions.

Charles Mackay, in his book “Memoirs of Extraordinary Popular Delusions and the Madness of Crowds” published first in 1841 wrote: “The demand for tulips of a rare species increased so much in the year 1636, that regular marts for their sale were established on the Stock Exchange of Amsterdam, in Rotterdam, Harlaem, Leyden, Alkmar, Hoorn, and other towns. Symptoms of gambling now became, for the first time, apparent.”

No Place for Speculation

There is, however no place for speculation in your retirement plan. The fact that they exist at all, is the largest hurdle any investor, especially one interested in building his portfolio for retirement, has to face. As I mentioned previously, the presence of a bubble or the effects of its aftermath tend to leave many investors indecisive.

Even as he wrote his paper, he wondered about the state of the stock market. “Currently the U.S. stock markets are in the late stages of what looks like a speculative bubble.”

While I go into great detail (in the book) about what is important to consider when bubbles exists, and how to invest your way through them, folks like Mr. Freifeld will sound warning bells well in advance of the impending disaster. But it is something you can ignore.

If your retirement planning is based on a conservative approach, a common sense approach if you will that rises above speculation, you will have no need to pay heed to those warnings. Believe it or not, you can win in any market situation.

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