What’s an investor?

This is what runs through my head as I sit hear waiting on the Steelers vs Patriots. I thought it would be fun to
post and get feedback on.

Anyone who follows the financial markets hears it every day. Investors moved the market. Investors didn’t like the
information released today. Investors are looking forward to the unemployment statistics. According to every
and any media outlet, if a market moves, it’s due to investors.

Wrong.

When it comes to public markets in particular, I don’t know if investors even exist anymore.

We as individuals can do any of 3 things with our money.

1. We can spend it.

2. We can save it in a manner where we have 99 pct certainty our principal cannot decline (Typically a
bank)

3. We can decide to accept some level of risk in order to earn a return on the cash or assets we have available to
deploy.

If we decide we want some risk in our lives, we have the choice to decide where to put those assets ourself, or
hire someone else to do it, or some combination.

At this point the decision is made to speculate or invest.

The difference between the two is very simple. If you spend the money and the only way you can earn a return on
that money is by selling whatever it is you have purchased. You are speculating.

If you give your money to a person or company, and that money is used directly to create commerce or to create an
asset that will be used in commerce and if there are profits from that commerce that can be returned to you as a
result, that is an investment

If you buy a house, rent it out, maintain it and make money from the rent and increase its value through your
efforts, that’s an investment. If you give money to someone to do the same, that’s an investment.

If you give the kids next door 20 bucks to help setup a lemonade stand in exchange for splitting the profits.
That’s an investment.

If you help fund a startup and you are due your percent of the profits, if any. That’s an investment. If that same
startup has an exit strategy of going public and the only way you can earn a return is if the company goes public or
gets bought, thats speculation.

If you buy a share of stock that doesn’t pay dividends that reflect the company’searnings, a baseball card,
artwork, a coin or stamp collection, in hopes of making money by selling it at some point in the future. That’s
speculation.

If you hang that art on the wall. Get excited about having a 1968 proof set, or the history behind First Day
Covers. Tha’ts collecting. The price movements are just a bonus.

If you buy acorporate or municipal bond. That’s still speculation, butat least you were smart enough
to buy something with a “get your money back ” schedule.

If you buy stock in an IPO or secondary. If the money goes to the company and is actually used for operations and
that company returns earnings to its investors from operations in the form of a dividend. That’s an investment. If
the only way to get your money back is to sell the stock, that’s speculation.

If you give your money to a mutual fund or hedge fund that puts money into public stocks and bonds, that’s super
speculation.

Why Super Speculation? Because there is a 99 pct certainty that you are 3rd in line to get paid with whatever
earnings the fund generates with your money.

First the fund itself has to get paid. They take money off the top.

Then the person who makes the investment decision has to be concerned about keeping their job. You see if the fund
doesn’t outperform its peers or comp indexes, then the person who is responsible for the fund is out of a job.

Do you think that person cares more about putting a roof over his family’s head or you? Which means when push comes
to shove, unless there are strict limitations, that fund manager is going to take the chances necessary to outperform
his comps. And I can tell you that its par for the course to “go down swinging” than it is to take a called 3rd
strike. Meaning, they risk your capital in hopes of keeping their jobs if that’s the only way to keep their jobs.

Are you an investor or speculator?

It’s not that it’s right or wrong to be either, but it does make a huge difference in our economy and national
well being.

When money goes to create commerce, that’s capitalism at its best. Money going to smart people to do smart things.
If it has good results, everyone makes money. The economy grows. Expectations are based on the prosperity of the
company, typically over a longer term. New ideas create new wealth. It’s not a zero sum game. It can be an
everyone wins game.

Speculation isn’t a bad thing. It can serve many purposes, but it primarily just results in redistribution of
wealth. If I speculate better than you, even if you are investing in apples and me in oranges, then its just a
contest to see who does a better job. The winner gets the cash. Across all the different levels of speculation, the
trillions of dollars, its a zero sum game.

IMHO, and this is obviously just my opinion, the problem is when the balance between the two shifts from heavy in
investing to heavy in speculation.

Speculators invest purely to gain an annualreturn based on the risk they are willing to accept. This has
lead to huge businessescompeting to attract speculative money. This has lead the public equity markets to
evolve from being primarily a source of capital for growing businesses to primarily a means
ofextractingwealth for insiders and speculators. Companies don’t go public to grow, they go public so
people can get rich.

I’m not saying there is anything wrong with making money anyway you can in the market. There isn’t.

I do think it’s important to understand the expectation behind money. It can help us understand why irrational
exuberance is rational. It can help us understand why bubbles happen. It can help us understand why markets don’t
react like you would statistically expect them to so often.

When most of the money being ingested into our public markets is speculative, then the competition for returns
increases. When the majority of speculative money is deployed by funds, who must compete with each other, and within
which fund managers must compete to keep their jobs, the amount of risk acceptable for any given level of return
increases.

This only works as long as new money continues to come in. As long as people keep streaming part of their
paychecks every payday to mutual funds. When the money stops flowing in, there is no one for the speculators to sell
to and the prices start falling and everyone starts freaking out.

On the other hand, when money is invested to create and grow companies, that leads to economic growth and
jobs. When returns are based on corporate performance and paid in cash, thats a return on investment.

If we want to see the economy grow faster, eliminate taxes on cash returns paid to investorsfrom operating
profits. If someone investsin a business, any profits returned to the investor in a year,up to the
amount in profit declared to the IRS and on which taxes are paid by the company, that amount should be tax free.
Every year in which they are paid.

HOWEVER, if I sell my investment in that company, I pay taxes on the gain at that point and that tax
immunity doesnot travel with the investment. Whoever I sell my shares of lemonade inc to pays taxes on
any dividends they receive from the company.

This would be a way to see capital redeployed from speculation to investment. I personally think that we
would see a positive impact on the economy as capital would be more readily available for small business startups,
and it would make it more patient capital since there would be an incentive to get tax free dividends rather than
executing on an “exit strategy”

All of which is a good thing for the long term economic health of the country.

But this is all just my opinion.

67 thoughts on “What’s an investor?

  1. Speculators are just following Adam Smith’s invisible hand–why work your butt off for a return on sweat equity when you can make triple digit returns flipping condos and Chinese internet stocks?

    Comment by runescape money -

  2. Just think how complicated accounting procedures are going to have to be to ensure no one is using your idea as a tax haven. Imagine filling out a 1030 form, except stricter regulation. I mean strict as in Olympic steroid testing strict. Standing-over-you-as-you-pee strict.

    Comment by wow powerleveling -

  3. Follow the Buck:

    Hi All,

    It is always wise to follow the buck –Anytime research reports are written, one has to carefully review who is writing them. Third party reports (non-brokerage) are seldom used for my investment purposes because in the end the current numbers are all that matters. The future is always speculative -regardless of WHO says WHAT. The worst part of these types of reports is that is lowers the overall credibility of everyone in the investment business as looked upon by individual investors.

    FYi, Webmaster*SAM
    Self_PLUG: A search for Excellence: http://www.p31.com

    Comment by Webmaster*SAM -

  4. Mark,

    Thank you so much for sharing your thoughts and insights. I subscribe to your blog and read every post. You represent the two great passions in my life technology business and basketball.

    IMO, most of the money on wall street is speculative…a form of legalized gambling…with no better odds of success. We are taught in business school how to “run the numbers” and analyze results. But, in the end it is all about emotions…fear and greed.

    I wrote an entry in my blog, The Next Big Thing, titled “Fear is temporary, greed is permanent” http://dondodge.typepad.com/the_next_big_thing/2005/09/fear_is_tempora.html The premise is that markets are driven by two things; fear and greed. When fear takes over investors move to the sidelines or to safe havens. But fear is temporary. Greed is permanent. Greed takes over when investors see others making some money. They jump back in before all the easy gains are lost.

    I agree that tax policy drives investment behavior, and agree with your ideas on dividends and start-up investments.

    BTW, I saw you speak at the Streaming Media Conference in San Jose about 6 years ago. I was on a panel at that same conference. Your passion was amazing and inspiring. You haven’t lost that passion and probably never will.

    BTW2, your posts on the Steve Nash deal, and the Michael Finley situation were a treat. No sports writer could ever write that story. It is truly a privilege to get your inside perspective on these amazingly complex and personal decisions.

    Thank you for sharing!

    Don Dodge

    Comment by Don Dodge -

  5. Darius,

    Devil’s advocate: The process of the companies being “stuffed” or “stacked” into the S&P 500 is not perfect. Nor is the choosing of which stocks to keep in the Dow.

    For example. I wouldn’t qualify the adding of Yahoo to the S&P 500 late in ’99 at that nose bleed value… “investing”. The collapse after it was added did nothing but drag the average down because when they added it to the SPX it’s capital weighting was so big and the re-allocation of index funds into YHOO literally caused the blow off top on it at that time.

    Even with the faults involved with the way stocks are put into the indices, it is a way for joesixpack to deworsify without getting totally raped by management fees. In fact you might as well just go with the S&P 500 Depository receipts or other trackers. In most cases you’ll see lower annual fees.

    More importantly, you’ll be able to better control your tax implications should it be held in taxable accounts. Because even index funds could one day see liquidations from say a complete panic in the market. And then at the end of that year the shareholders could end up dealing with net redemptions the fund experienced that triggered capital gains from years of net inflows into the fund.

    This is also exactly why the 2001 selloff into April was so bloody. Even though many mutual funds (mostly tech) showed down years in 2000, they also had net redemptions (outflows) that triggered having to book gains from years prior. Then shareholders got fed tax bills for capital gains from holdings liquidated even though the NAVs were down on the year.

    For this reason I would opt for the trackers over even a vanguard to play a long term buy and hold.

    Comment by Michael -

  6. Good point by David on index funds, especially if index fund shares are buoght for long term (I mean, decades).

    Comment by Darius -

  7. …and this wouldn’t be the case if the current tax laws were not as they are now.

    In fact it would not surprise me if there were all sorts of “exchanges” of sorts for small businesses and startups to meet potential investors if it was really worth it for investors (after tax). And it would likely be initiated by investors to even setup such exchanges.

    Comment by Michael -

  8. Mark,

    Tax rules should encourage payouts to investors (dividends) so that true “investment” start-ups can even garner the interest of angel investors and the like. And tax laws shouldn’t make it so that spending like whores on inventory or goods to avoid paying taxes each year (spend it or lose it).

    Another problem that exists is the one I have. I went from W2 income to buying houses at deep discounts and then spending money on fixing them up for long term rentals. Now I can’t get bankers to loan me a dime for startup ideas because I don’t have a traditional W2 income a.k.a. “job”. Even with assets they don’t care and see me as a risk.

    And angel investors don’t want to be bothered because I only need about $40K to $50K to take things to the next level and it is not worth their time. Then of course there is the problem with the public being so used to easy (read “brainless”) investments like mutual funds, that they don’t even look elsewhere.

    And because of the tax laws and the way the investment food chain is currently setup, it is not easy for a startup to even know where to look for startup dollars on this scale. The scale being… invisible to bankers and too small for angels.

    Hell even the angel investor “brokers” can’t be bothered. It would be nice if there was an “exchange” or open forum where one could solicit investors without having to pay hundreds to thousands of dollars just to present/pitch the business plan.

    Comment by Michael -

  9. Ummm Mark, shouldn’t it be here not hear in the first line?

    Comment by Stephen -

  10. I disagree. Although I respect your opinion and there is merit to it, your idea of “investing” money into a vehicle that creates commerce and returns to you REAL money, in terms of profits from business operations or dividends on common stock in essence is no different than how you define speculation. When you invest into a business, like vc’s may do, there is just as much inherent risk and “speculation” involved in creating that commerce as buying 100,000 shares of Delta Airlines, so you can take advantage of all the volatility and daytrading to make a quick buck. Sure, speculation in trading stock is motivated by money and probably doesn’t serve as a engine for job creation, to drive any sort of innovation, and all that other good stuff, but it isn’t any more speculative than investing in the lemonade stand that may not generate any revenue and/or profits at all.

    So was “investing” in mamma.com investing or speculating?

    Comment by Ken -

  11. excellent article…I think the majority of market participants don’t understand and/or appreciate the points you bring up, simple as they are, or they disregard them because they want to make money. the noble goals of the market system then become lost by speculators and faux investors. I think enough of this is due to human nature that things won’t change, which is unfortunate because a true, principled investor can be marginalized when the market is driven by speculation, and you have little choice but to join their game. I don’t believe in stock picking; to me true investment only comes when you are involved in some way in the entity. this can range from keeping yourself informed of a company’s activities and making your shareholder’s voice heard (though sadly if you’re anything but a major shareholder your voice is likely to be but a whisper), or holding stock in your company.

    I don’t mean any of this to be judgemental – I want to make money like everyone else, and if I find a good speculation opportunity I’ll go for it, even if I perceive it as undermining the principled premises of the market system. but raising the distinction is something that is not done enough, and a real understand for and appreciation of the difference can lead to a better market for all.

    if you’ve got the stomach for it (I think you’ve shown you have the guts), I agree with the previous commenter’s suggestion of pursuing political office. we badly need some rabblerousers in government, and even if I don’t always agree with you, I can definitely relate to you. except for the whole billionaire thing. I’m working on that.

    Comment by no one -

  12. Very interesting comments Mark. Very interesting view on how to get the economy going again. I wonder if there is anything to back up your opinions.

    Comment by Larry -

  13. It’s unfortunate that raising capital for a startup is directly related to the exit strategy. If you can’t provide a substantial return for the investor by going public then it hardly seems worth the risk. A small business loan with government backing is financially limiting and is designed for an existing business model like an ISP versus a new unproven business model. Combined these financial challenges make it very difficult for the entrepreneurial spirit to execute on what is know as the American Dream.

    Comment by Scott -

  14. Hi Mark,

    Did not you become rich “speculating” by founding a company, broadcast.com, that did not generate much dividends but was sold during good times?

    Speculating is kind of needed if you want to get real rich quick?

    -n

    Comment by Niklas -

  15. Mark, have you ever considered running for a political office? I realize that the inefficiencies of politics would probably drive you crazy, but competent people need to enter politics to change that. I definitely could imagine voting for you if you would run for senate . Just my two cents.

    Comment by Kevin Klotzbucher -

  16. Mark, dude you’re thinking this as the Steelers were throwing away a game??? Dude, have a beer, some nachos and relax!!! It’s football season!

    Comment by Dewey Wurdman -

  17. Hi Mark,

    My Opinion…….A lot of lower and middle class individuals “speculate” because they believe it to be their best chance at attaining a better life. Most average folks don’t have the financial wherewithal to seek out real quality “investments.” Why do you think so many people stand in line at the corner 7-Eleven, waiting to buy a lotto ticket, or a scratch off? Same concept with stock market speculation….

    I technically trade the “cheap” stocks for reasons I mentioned above. Trying to climb out of the lower-middle class is a monumental task, given all the disadvantages. Some banks/credit card companies charge people like me a 30%+ interest rate on debts owed. Personally, I’ve never missed a monthly payment, but that doesn’t matter because it’s their game, their rules.

    I don’t think it was a coincidence that online trading became so easily accessible and prevalent just prior to the 1999/2000 bubble burst. It was all by design….Lure in as many people as possible, then let the bottom fall out.

    The rich control the world and the game is rigged. Some people believe they have no choice but to speculate. Just my opinion….

    BTW….My comments aren’t directed at you personally….Thanks, Jim

    Comment by Jim Parham -

  18. Mr. Cuban,
    I have read your comments on “that’s the way it’s always been done” and I just finished reading investor or speculation.
    Which are you?
    On Monday, Sept. 19, 2005 @10:45 a.m. I e-mailed you on, Ask Mark, Maverick web site and am anxiously waiting for a reply. I’m a novice at the computer, so I hope I didn’t do anything wrong in trying to get your attention on an important matter concerning our country’s cybersecurity. I sincerely hope you will read that e-mail.
    I have added your web sites to my Favorites!
    Thank you for your time,
    Grace Byrd

    Comment by Grace Byrd -

  19. Well done, Mr. Cuban…isn’t it unfortunate that most of the public spends more time comparing shoes than on comparing potential investments and/or speculations? Personally, my temperament has lead me to be more of a speculator, but there’s no doubt that capital for investment deserves our best possible treatment. What better way for our country to maintain its edge than to incentivize the masses to invest in small business?

    Comment by derek -

  20. What else is amazing about speculation vs investing? Whenever I hear some armchair “investor” give me an “investment tip” it always ends up being pure speculation. I love to ask “how many shares do you own”? The answer is always none…then why is it a good idea for me to “invest”…er I mean speculate.

    A perfect example is charter. I’ve been told the Charter’s only a buck something right now…it can’t go any lower…I love to point out it can go to zero. And who cares anyway that its only a buck something…thats only relevant if theres only 10 shares.

    Comment by Greg Wilson -

  21. Interesting comments, Mr. Cuban.

    I’m wondering, would you classify index funds, stock or bond, as investments or speculation?

    Comment by David -

  22. I learned a hell of a lot from this blog. Mark you should teach a class.

    By the way, when I wrote you had only been right once as regards to business, I meant in a fashion that was obvious based on the results. It takes a lot of good decisions to maintain and grow wealth but I and others aren’t necessarily privy to those.

    Comment by James King -

  23. We might have to first re-educate – if not educate – our populace about free market capitalism before we employ your sensible, thought-provoking strategies.

    “New ideas create new wealth. Its not a zero sum game. It can be an everyone wins game.”

    Seemingly, and unfortunately, the only people who believe this anymore are the wealthy and the entrepreneurial. Everybody else appears to believe that our economy is indeed a zero sum game. i.e., “hold onto your job at all costs” typically wins over “be more productive and more efficient”.

    Which easily translates into “speculation” winning over “investment”. In the end, our economy remains vulnerable to others.

    self-plug: New indie music video show coming soon…

    http://sosohot.com/eDonkey_Indies_Teaser.wmv

    Comment by Charles -

  24. Yeah, great comments!Your blog is the best!=)

    Comment by Rob Roy -

  25. Yeah, great comments!Your blog is the best!=)

    Comment by Rob Roy -

  26. To me my friend suggests to open small firm on sale of computers and office equipments. Because I have an idea, and at my friend to money. That is it wishes to invest my project and to be the partner. And still yet I do not know to agree or not!?

    Comment by whales -

  27. very good!

    Comment by 11nong -

  28. i was searching then i got this idea from google now m going to join this prog…. i think it w’ll be hopefull …….well lets try

    Comment by ZEESHAN HASSAN -

  29. These are simply the disadvantages of the westren financial systems. That’s why rich people are getting more rich, poor ones barely afford their life expenses and still go down. Poor or non-rich people are being used by large business owners as modern slaves, you’re not free as long as you fear losing your job, miss those few pennies you live on. Believe me, the main cause for this is that usury system used by banks and other entities, better known as “interest”.

    Comment by Computerization -

  30. These are simply the disadvantages of the westren financial systems. That’s why rich people are getting more rich, poor ones barely afford their life expenses and still go down. Poor or non-rich people are being used by large business owners as modern slaves, you’re not free as long as you fear losing your job, miss those few pennies you live on. Believe me, the main cause for this is that usury system used by banks and other entities, better known as “interest”.

    Comment by Computerization -

  31. Graet artikel and great comments!
    @ David:
    I would you classify index funds, stocks and bonds as speculation. The cours can rise and fall very quickly.

    Comment by Art -

  32. From most of the comments, you would think that speculating is akin to robbing a bank guarded by sleeping elderly women, or selling porn to 13 yr old boys. First of all, if its so easy to make money in speculation then why aren’t YOU doing it? That’s right, it’s not because it’s evil, it’s because you don’t know how.

    Comment by auction systems -

  33. Mark,
    The most important concept in your discussion is about Americans misunderstanding where true wealth originates. Most people don’t know that if America is going to stay competitive with the world MANY people are going to lose their jobs because we HAVE to become more productive, more competitive, and more INNOVATIVE.

    People complain about losing jobs to other countries where labor costs are lower but if all the other international companies do the same thing that would make American companies the most expensive and nobody would buy products or services from American companies.

    In order to survive and excel in the new global economy we need three things:
    1. A government that encourages people to start new businesses via tax breaks and grants.
    2. Better patenting processes and protection.
    3. More funding for colleges who encourage entrepreneurship.

    Too many people say: I’m going to be a doctor, fire fighter, etc when I grow up.

    More people should say “I’m going to develop a better technology for doctors, fire fighters etc.

    Comment by Money Market Man -

  34. Mark, Mar, Mark:

    It is no wonder why The Donald kicks your butt!🙂

    While The Donald may be even less successful, at least he’s not as apologestic as you are, when it comes to making money or rather how it’s made.

    So, let me see if I can follow your [miss]logic. Somebody starts something from gound up and all money put into it is deemed to be “investment”.

    The new venture may start paying dividends or it may end up ReINVESTING those dividends into the business. In this case, the INVESTORS get paid through stock price appreciation, instead of dividends. However, it’s still investing because the business growing instead of paying a dividend.

    Eventually, the business starts maturing and it’s growth starts slowing down. We, your type of investors, are no longer interested because after all we are interested in NEW VENTUREs, but are now stuck and can not get out.

    In other words, EVERYTHING is investing and all you have done is played with words or semantics – NOTHING more and nothing less.

    Having said all of that, one might want to use the tax system to perhaps reward earlier risk, throug lower taxes.

    However, do you want such tax breaks to be causing stampede exists out of ongoing established enterprises?

    In either case, once I decide to no longer stick around, you can NOT penalize me nor another investor for taking my place – even if his subsequent risk is lesser than my original one.

    Mark, your DUMB LUCK is that you were in the right place at the right time. Your DUBM LUCK is that you were able to take advantage of those that were DUMBER THAN YOU. Your DUBM LUCK is that those DUMBER THAN YOU were able to take advantage of the rest of US DUMBEST INVESTORS.

    Comment by Joe Camel -

  35. Mark, Mar, Mark:

    It is no wonder why The Donald kicks your butt!🙂

    While The Donald may be even less successful, at least he’s not as apologestic as you are, when it comes to making money or rather how it’s made.

    So, let me see if I can follow your [miss]logic. Somebody starts something from gound up and all money put into it is deemed to be “investment”.

    The new venture may start paying dividends or it may end up ReINVESTING those dividends into the business. In this case, the INVESTORS get paid through stock price appreciation, instead of dividends. However, it’s still investing because the business growing instead of paying a dividend.

    Eventually, the business starts maturing and it’s growth starts slowing down. We, your type of investors, are no longer interested because after all we are interested in NEW VENTUREs, but are now stuck and can not get out.

    In other words, EVERYTHING is investing and all you have done is played with words or semantics – NOTHING more and nothing less.

    Having said all of that, one might want to use the tax system to perhaps reward earlier risk, throug lower taxes.

    However, do you want such tax breaks to be causing stampede exists out of ongoing established enterprises?

    In either case, once I decide to no longer stick around, you can NOT penalize me nor another investor for taking my place – even if his subsequent risk is lesser than my original one.

    Mark, your DUMB LUCK is that you were in the right place at the right time. Your DUBM LUCK is that you were able to take advantage of those that were DUMBER THAN YOU. Your DUBM LUCK is that those DUMBER THAN YOU were able to take advantage of the rest of US DUMBEST INVESTORS.

    Comment by Joe Camel -

  36. It takes guts to invest and only greed to speculate. There is a difference

    Shoelover

    Comment by Shoelover -

  37. I just found this site, interesting thoughts. In the classic sense, options are speculation vs. the investment in the corporation itself. In my opinion, the distinction is easy – investing in anything you don’t understand is speculation…period.

    Regarding your comment about “If you buy a share of stock that doesn’t pay dividends… That’s speculation.” I don’t get it – Modigliani and Miller probably wouldn’t either.

    Comment by Marc -

  38. It seems inappropriate to categorize speculation and investment solely based on the payment of a dividend. Microsoft didn’t pay a dividend for 25 years. Did that mean it was speculation? With businesses that are not paying dividends on their interest, one assumes this is because they are finding ways to profitably reinvest their own profits. If a business can no longer profitably reinvest its earnings, then it should pay dividends to investors – or do other things to increase shareholder value, such as repurchase its own stock.

    In a world where dividends were taxed as ordinary income (or, in some cases, more than ordinary income, such as states that only tax interest & dividends), it’s unsurprising companies would have an impetus to increase shareholder value by increasing the value of the company itself, allowing investors wanting cash to sell some of their holdings and realize their gains as capital gains rather than dividends. Also, if a company regularly pays dividends, and you reinvest that money, you are reinvesting the after-tax (technically, after double tax, both on the earnings that paid the dividend and the dividend itself), you are forced to accept the returns on the after-tax amount, whereas if the company can profitably reinvest its earnings, you compound your pre-tax amount. Why give it to the government if you can earn on it in the mean time? (In other words, for a dividend to be better, the amount earned by reinvestment of earnings must be less than a potential dividend YOU invest subsequently, minus the tax consequences of receiving the dividend).

    The value a company is, to paraphrase Ben Graham, the time-adjusted value of all its future earnings. An investment is one in which the market value you can purchase a share of a company for is less than that share of the company’s time-adjusted future earnings. Speculation is anything in which no such assessment can be made or a case where you decide to buy despite having a negative expectation. If you decide to buy Tulips simply because you think other people will pay more for tulips, despite the fact that you believe the inherent value of the tulips to be less than what you’re paying, you are speculating.

    So, in other words, investing is placing money where you can make an empirical assessment of returned value, and speculation is purchasing something where: (1) You cannot or do not assess an expected return or (2) You must rely on other people being “more irrational” to gain a profit (the tulip scenario) or (3) You assess a negative rate of return and invest anyhow for other reasons

    Even someone who buys a dividend paying stock is speculating if they do not understand what they are buying or what their expected reutrn is and why, and what sort of risks their investment may face. Good investing is about finding and exploiting gaps in market value, whether that means buying undervalued stocks or funding underdesired startups.

    Comment by MattW -

  39. Over in Australia, the tax situation is exactly like you wished. Company dividends are accompanied by tax credits, which is tax that has been already paid to the government. The shareholder can use the tax credits to offset other tax paid, and in some cases, even get to claim money back from the government.

    However, don’t go packing your bags and head over here. It is big business country, and no one can launch a TV station without political connections. There are a lot of laws which create monopolies or duopolies in Australia.

    Comment by Chui Tey -

  40. I agree with what you said, and have forwarded this blog entry to some friends of mine that I discuss investments with. They are always talking about “Im getting into this stock because it should go up because…” and I tell them the only reason it’s going up is because some other fool is going to buy it for more than you bought it for, and that’s about it…and that I don’t like to rely on the foolishness of others, or rely on others’ lack of foresight.

    I started feeling this way 2 1/2 years ago when I was looking around for something that paid a little better than a bank (bank interest rates were less than 2% at the time). So I did a stock screen based on yield %. What I found were REIT’s and Energy Trusts had really good yields, and were based on taking a slice of the profits and sending them to investors.

    So I called up a company (Capstead Mortgage there in Dallas) and said I was looking for something to invest in, but that I was worried about the risk, and the person was very helpful.

    She said “oh, you probably would like our preferred Series B stock…it pays 10.5 cents per month every month..and has been doing so for 10 years”. The stock was selling for around $12 at the time. I did the calculation, and thats better than 10% ! that kills keeping the money in the bank. It’s 2 1/2 years later and the stock is still around $12, and still pays the same dividend every month.

    I’m not trying to pump the stock…I mean, the price barely moves. I’m giving the details of how looking at income over growth helped me.

    Keep up the great blog entries!

    Comment by Zeke -

  41. Mark Cuban wrote: >If you spend the money and the only way you can earn a return on that money is by selling whatever it is you have purchased[, y]ou are speculating. If you give your money to a person or company, and that money is used directly to create commerce or to create an asset that will be used in commerce and if there are profits from that commerce that can be returned to you as a result, that is an investment< Information has value. By buying and selling, people share information about their personal assessment of goods and services. In effect, they create signals, and these signals are used in commerce. Signals, in fact, are absolutely critical to commerce. The characterization of speculation presented by Mr. Cuban is essentially the old Soviet view of finance. It doesn't work. Elucidations of the value of information and signals in commerce are included in any number of widely used economics textbooks. My partner and I, Victor Niederhoffer (B.A. Economics, Harvard, PhD Statistics, U of Chicago), have many book recommendations on our Web site, http://www.dailyspeculations.com, that discuss the issue at length. Heyne’s “The Economic Way of Thinking” is particularly well written.

    Comment by Laurel Kenner -

  42. Index funds are not investments because the profit from an index fund is almost entirely (or entirely) derived from stock price growth driven by speculation in the greater market (specifically among whatever stocks are included in the index) driving up the price of index shares.

    Instead of being the boat, you’re being the stowaway rat, but you’re still counting on that speculative tide to lift you.

    Comment by Jeremy Goodwin -

  43. Index funds are not investments because the profit from an index fund is almost entirely (or entirely) derived from stock price growth driven by speculation in the greater market (specifically among whatever stocks are included in the index) driving up the price of index shares.

    Instead of being the boat, you’re being the stowaway rat, but you’re still counting on that speculative tide to lift you.

    Comment by Jeremy Goodwin -

  44. Hi Mark,

    I think this is a great idea, to eliminate taxation on cash returns paid to investors. As an independent record label owner who has and is raised money under a profit sharing model I believe it would be a greater further inducement to existing and potential future investors should they be free from taxes on cash returns paid out.

    By the way we met at the Hollywood Roosevelt hotel last month and you are airing our music video on two HDNet shows…thanks!

    Jesse Krieger

    Comment by Jesse Krieger -

  45. It is a great article to read. I have similar
    funny article posted at : http://www.stock-article.com/

    Thanks,

    Comment by Gautam Dev -

  46. William Berstein has written some great articles at efficientfrontier. In particular he wrote an open letter to the new (well now old) SEC chairman. CPA’s and medical doctors have extensive education and licensing, but financial professions can be the guy off the street and the series exams are a joke. The CPA and medical professional have a fiduciary responsibility to their client, the financial professional does not. I hate to say it, but in this “culture of corruption”, a lot of good people thought they were investing for retirement because they trusted financial professionals and oversite entities. It is really hard to tell the really slimy snake oil salesman from the Wall Street financial professionals. I really dislike people like Jim Cramer, who were/are speculating but convinced people they were investing and saving. At one time after the bubble burst, he even apologized, but I think over time he is reverting back. Even if companies make money these days, if you look at the CEO, execs, and the corporate board oversite, it is really sad.

    We always hear that investors will do the right thing, that shareholders will cause the company to “act” appropriately. I just met someone that is investing in what I’ll call an “unethical” company. His response was, if I don’t invest in it someone else will. That brings me to the “efficient” allocation of money. We haven’t invested in our infrastructure for many years now, and I think those projects don’t get done when you just count on the markets… because the things we need to do to maintain our society aren’t glamorous.

    We have dentist, doctors, CPA, tax preparers, building contractors, plumbers, electricians, scientists… all these people are trained and experts in their field and we are suppose to be able to “trust” (after doing appropriate homework) them to follow their “code” in a reasonable manner. In turn, they should be able to trust a financial professional. All those other professionals bring us value in some form. A financial professional is the only one where they can lose value — and still take your money.

    I absolutely agree with Justice Litle entry on the Feds… The cost of the Iraq war (5.6 billion/month) and the cost of the Gulf coast cleanup/rebuilding in the tune of hundreds of billions, plus our current debt and fiscal policy is really concerning, not to mention the state of energy.

    Comment by Turalee Now -

  47. Dear Mark,

    Great read! I have been thinking about this for some time as people ask me what do I do – for the most part they say I am a real estate investor but in my estimation I am a real estate enterpreneur. I agree that in the current uptrend markets like FL and AZ that it is easy to say we are “investing” but for the most part I would say it is close to “speculation”. The nuance is lost for many who don’t know the difference as they are enamored by the vehicle – real estate. I appreciate your clarification as I also agree that both are ways that our free market system works. As long as people who want to proceed with each venture with the goal to increase one’s wealth then proper risk managment is warranted.

    Thanks again Mark!

    Comment by David -

  48. Great Article. I created an entire blog just to discuss the subject of speculation and greed in the market. It’s located at http://www.rawgreed.com

    I hope you can give it a read and some comments.

    Best,

    Andy

    Comment by Andy -

  49. Nice idea, but it’s something only “sophisticated” investors and tax accountants will pay attention to, another page in a bloated tax book. The rest of the public (i.e. the majority) will continue to “speculate” in their houses, while the government continues to waste most of our money. Now if you wanted a REAL challenge, figure out how to eliminate pork barrel projects; that’ll save some serious coin.

    Comment by csr -

  50. Mr.Cuban Sir,

    Would you please write a column on your investment in Tucows? All you ever commented on this stock was a 2 sentence blurb in an interview.

    Man of us would really like to hear your take on it. What do I have to do to get your comments on this? I live in Bangkok and I could send you a bottle of Thai snake juice that is an aphrodisiac. Would that do the trick?

    Really Mark, TCX investors feel like we could use more support. We were hoping you would say something on CNBC but we realize with TCX being such a small fry, it probably would have been inapporiate.

    Please say something more about TCX….Please with sugar on top. Please with double sugar on top.

    Comment by PJM -

  51. OK Mark, I hear your spouting loud and clear so why don’t you come clean with us? Tell us what you are up to with the RCOM/TCX combo investment. Do you just think domain name registrars are undervalued or is there more?

    Rumors in Toronto say you will become the director at Tucows. Is that true?

    Also, you are trying to block the sale of RCOM. Is this so you can merge it with Tucows and have Tucows management (that you love) run the merged company?

    Come on, let’s hear it.

    Comment by Patrick Jones -

  52. Hey, I really enjoy your writings about business/investment(/speculation). Keep it coming!

    Comment by Dustin Sacks -

  53. Is rebuilding New Orleans a speculation or an
    investment?

    Comment by val barrutia -

  54. I totally disagree about your distinction between an investment and a speculation. Just my 2 cents. Purely semantics.

    Michael
    http://michael75.blogspot.com/

    Comment by Michael -

  55. I second the podcast comment. Go ahead Mark, you can do it.

    Comment by Mark Goodchild -

  56. Mark, nice post! I’m an investor/speculator myself and based on my experience the borderline between speculations and investments is, unfortunately or not, a nice foggy grey area. I’ve had speculations that turned into investments and vica versa. Neither is particularily good or bad as long as you have time on your side.

    Comment by Ben Neumann -

  57. Excellent post Mark. It’s equally important to realize what isn’t an investment. For example, the vast majority of people believe that buying a home is an investment. It is not. Building and selling a home can be an investment. The homebuilder invests capital to build a home in hopes of profiting on what has been created. The homebuilder uses commodities and other products to create a new product. The homebuilder is a producer. The homebuyer who buys a used home is not an investor. Homebuyers are speculators because they hope someone else will want to buy their home for more than they paid for it in the future, but they do not produce or create anything new, unless they substantially improve on the property.

    Comment by Mark Mahorney -

  58. Well said. To add my 2 cents…I think the best litmus test for identifying when capital allocation is “investment” grade, and when it’s more “speculative” — is discerning whether it delivers *net positive cash-flow* over a discrete, measurable period of time.

    Comment by Jeff Z. -

  59. Mark:

    Your proposal is essentially to make dividends tax free. You have a slight qualifier in that the dividends have to be paid from operating income (i.e. you can’t just pull cash off the balance sheet in the case of a company with negative operating income).

    I agree with you on that notion.

    You also touch on something which continues to be a warning signal to me: people are continuing to pour money into stocks and bonds via the mutual funds in their retirement accounts, without having any clue how their money is being managed, and what they’re paying the fund managers.

    For example: there are folks who think “I should get a little more conservative” and decide they should shift from their hi-cap equity fund to a bond fund. They look at the list of bond funds and decide that “high yield” sounds pretty good, and so buy in. They don’t realize that high yield bond funds invest in junk bonds that might well be a higher risk that the equity funds they traded out of. Or that when interest rates go up, the value of bond funds go down.

    I went through most of the 90s arguing with friends about dividends. They would say that dividends are passe and that the best return comes from letting the company keep your money and reinvest it. Really? If you really believe that, then buy more stock. If the company pays me a dividend, I can choose to invest it back into the company, or use it for something else.

    But, as you imply, if the government taxes me on dividends, then it distorts things — I am encouraged to take the bet on letting the company keep my money and see if the stock price gets bid up. Taxes on dividends encourage speculation. That’s why we want to see dividend taxes eliminated.

    Like you, I used the real estate analogy: When you buy a share of stock and let the management keep the profits on the promise that they’ll make your investment more valuable, it’s like buying an apartment building and telling the tenants they can live there rent free as long as they promise to to maintain and enhance the property. In this case, your bet is that the tenants will fulfill their commitment and you can sell the property for a capital gain at some point in the future. Meanwhile you got nothing for your money. Paper profits maybe, but nothing real until you actually sell it.

    Folks should read a little Ben Graham or Warren Buffett before investing in the stock market. The key is to buy a well-managed and profitable company at a bargain, and make some money through a combination of dividends and capital gains.

    Anything else is a “greater fool” play. The buyer is an ignorant speculator (although there are professional speculators whom I respect) who doesn’t know why a stock is priced the way it is, but yet has hope that the price will go up because there are greater fools than he.

    Comment by Paul Lambert -

  60. Mark, we may soon see an interesting phenomenon as speculators try and turn themselves into investors. I’m referring to the house flippers, who will have to figure out some way to recoup losses and expenses on un-flipped dwellings if home values remain static or decline over the next few years.

    Comment by Aaron -

  61. start podcasting! Its too much to read…
    Thanks

    Comment by Ajay -

  62. Mr Cuban is using a broad definition for speculation. I can certainly see his point (he is, after all, a billionaire). Under his definition, though, pretty much all stock buying is classified as ‘speculation’.

    While I might agree on the logic he uses for this, the problem lies in the mechanics of
    the economy – how things actually work. Sure, it’s true that ‘investing’ can be limited to
    directly funding a business from the ground up, or after the start up point if more money
    is needed. This would be the case if your brother-in-law (or the like) came to you with
    a business proposal, and needed some startup money. If you agreed, you would be a
    partner in the startup business, and you would be entitled to share (by whatever agreement you had when you handed over the cash) in the profits – or the losses.

    So there has evolved the stock-market system, which allows people to invest in companies through a ‘broker’ – the investment company.
    The investor – you or I – never (or rarely) actually meets the people in the companies
    that they invest in, but the money gets there all of the same. The company gets the cash
    to set up their business, and you get to be involved in the financial end of things. Then,
    things get more abstract. If you received dividends from the stock you bought in the
    company, this means the company is paying you your share of the company’s profits
    (minus money they hold back for expanding the company, etc ..) Mark Cuban still
    considers this an ‘investment’, because there still exists a link (however indirect) between
    company profits and the money you receive in return.

    Then there is the next step. Stocks without dividends are merely pieces of paper that
    indicate that you ‘own’ a part of the company. You are entitled to keep the stock, and
    watch the company (and the value of the stock) grow. You are also entitled to sell the
    stock, just like any other product, and make a profit (or loss) when you do so. You don’t
    make any money at all until you sell the stock, though. Mark Cuban calls these people
    ‘speculators’ – I don’t. These investors still put their hard-earned cash into company
    revenues, just like somebody funding his brother-in-law. This ‘indirect’ investing, through a broker, instead of direct investing, is necessary for most people for at least two reasons.
    First, most people don’t have the expertise to determine which companies are a good
    bet to invest in. Second, most people don’t have the amount of cash available to provide
    a necessary investment in a company in this form – so ‘indirect’ investment (through an
    investment company) is necessary to allow several (hundreds, thousands .. of) investors
    to each pay a relatively small amount of money into a ‘fund’ which can sustain the company which needs the investment.

    The problem arises because there can be a disconnect between the actual value of the
    company and the value of the company’s stocks. This can be caused by various market
    forces (such as a shortage or excess of the company’s product available on the market-
    place). Among these market forces are the SPECULATORS. These people have enough cash, and influence, to cause the market to misrepresent
    the actual value of the company. You have to remember that, just because of a temporary
    shortage of the company’s product on the market, the stock will often go up – but the real value of the company hasn’t really changed – because the changed condition is
    TEMPORARY. The market as a whole usually knows that, and any changes to the value
    of the company’s stock is minimal.

    The speculators try to convince everyone otherwise – that the marketplace changes are
    fundamental, and irreversable. If they succeed, the value of the stock changes – and the
    SPECULATORS profit. They can profit whether the company’s stock rises or falls, depending on the moves they make. EVERYONE ELSE LOSES. The ‘investors’, caught off guard in moves behind the scenes (insider trading, etc..) lose value in their stock, the company loses the confidence of its investors (and thus their continuing investments in the company). SPECULATORS are PARASITES, profiting off other people’s misery. They ruin companies, and the investments of people who are putting their money on the line to make an actual profit from the company.

    Comment by Greg -

  63. I liked the persuasive speech about the difference between speculation and investing up until the end.

    Your idea regarding HOW to change an economy from speculative capital to investment capital seems pretty flawed.

    Just think how complicated accounting procedures are going to have to be to ensure no one is using your idea as a tax haven. Imagine filling out a 1030 form, except stricter regulation. I mean strict as in Olympic steroid testing strict. Standing-over-you-as-you-pee strict.

    How exactly do you plan to seriously introduce this idea and gaurantee it will not be ABUSED?

    Ideas should not be judged merely on their SUGGESTED uses, but also on how someone sees their POTENTIAL uses. And potential is not always a good thing. Potential often means potential for abuse.

    Look at Warren Buffett. He recently had a dispute with the government about paying taxes because of how he “interpretted” the tax codes. I’m not accusing Warren Buffett of scandal at all, that would be stupid. But I am pointing out that rich people do use the law to their advantage to make money. It’s a lot easier and safer to use the law to make your money than to try and commit an out and out crime.

    Comment by John "Z-Bo" Zabroski -

  64. I agree that speculation is a bad thing, and our country’s housing market is being fueled by rampant speculation right now.

    Comment by gas prices blog -

  65. It’s worth pointing out that rampant speculation is an effect rather than a cause. The source of the problem is the fed’s fiscally irresponsible easy money policies that have deliberately created asset inflation on a global basis. Speculators are just following Adam Smith’s invisible hand–why work your butt off for a return on sweat equity when you can make triple digit returns flipping condos and Chinese internet stocks?

    We are caught in the classic boom / bust cycle and rampant speculation is a natural part of it. 1) We build up mountains of debt by spending money we don’t have and blowing it in nonproductive ways. 2) The federal reserve monetizes the debt with long running easy money policies. 3) The fed’s easy money policies create persistent asset inflation, which attracts the speculators in drove. (Inflation in real goods and services is massaged away by hedonic adjustments and massaging of ‘core’ CPI). 4) Asset inflation created by the fed finally gets out of hand as debt piles up, the speculators run rampant, and eventually all fall down go boom.

    The speculators aren’t the ones to blame here. They have a functional role to play in the market ecosystem, and they show up to feast on the opportunities created by a pushover fed and a profligate government. The genesis of the problem is spending money we don’t have and trying to cover up our tracks. Not much different than the family that spends far beyond its means on credit cards, creating temporary happiness for vendors but long term pain for everyone.

    We don’t need more legislation and more rules to right all the visible wrongs that have popped up. We need to cut to the heart of the matter that caused all these problems in the first place.

    Comment by Justice Litle -

  66. Spoken like a true investor, Mark.

    Comment by Stock Pundit -

  67. I agree with your concept in principle. The biggest problem with your tax insentive idea is that it favors the very richest who are capable of investing in the IPO.

    In fact, in the months leading up to Netscape’s IPO, I called Morgan Stanley “To participate in the IPO”. They were very happy to hear from me until I mentioned that I didn’t have a MS account and I didn’t have $1MM+ to open a MS account. I quietly watched as the wealthy speculators laughed their asses off to the bank on the opening day. In the Netscape example, those early “investors” turned into speculators the moment they sold their stock with a 300% profit in a few hours.

    Everything doesn’t always have to be fair, but when it comes to dishing out tax cuts, they should at least pretend to take the small guy into account.

    I’m going to go back to watching you on SqawkBox. I normally just catch it from about the middle when I wake up, but I tivo’d it since you were going to be on. Keep up the good work Mark.

    Thanks for the post.

    Comment by Lost -

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