“Whether you’re excited or nervous when your favorite asset falls in price marks whether you’re investing or merely speculating.” – Naval Ravikant

Are you investing or merely speculating?

Naval Ravikant had an interesting take on this most important of questions (see above quote). The deciding factor: whether you’re “excited” or “nervous” to see your asset going down in price.

Why in the world would anyone be excited to see something they own moving lower?

Because it is giving them the opportunity to reinvest interest/dividends and add new capital at discounted prices. If you have a long enough time horizon and a diversified portfolio, buying at lower prices will increase your long-term returns. Which is why a stock market crash is the best thing that could happen to young investors.

How do you know if your time horizon is “long enough”? Examine the odds…

Holding stocks for a day or a week is not much better than a coin flip. In that time frame, you don’t have the luxury of waiting for stocks to come back and any decline should make you nervous. In contrast, holding stocks for 20-30 years has never yielded a negative return, even for investors who bought at the peak in 1929 and held throughout the Great Depression. If that is your time frame you want stocks to go on sale – the earlier, the better.

Data Source for all Charts herein: Bloomberg, YCharts.

The big money in markets is made with patience and time. The longer the time horizon, the more time to compound, and the higher the expected returns…

Short-term speculation can at times lead to extremely large gains (ex: 17% in one trading day). If you find yourself in such a situation, understand that luck – not skill – is the driver. The real skill? Saving and investing for long enough to minimize the role of luck. This, unlike fortuitous short-term gains, is a repeatable process.

One appeal of short-term trading is the notion that losses are truncated. This is generally true, up to a point. The worst day in stocks (-20%) is far lower than the worse month (-43%) or worst year (-71%). But at the 5-year mark, this trend begins to reverse course, and by 20-years the worst return was actually positive.

The worst 30-year rolling return in the S&P 500? 559% – which equates to an annualized total return of 6.5%.

The next time the stock market has a large decline, check your emotions. Are you exuberant or despondent?

The answer will tell you if you are an investor or merely a speculator.