Types of Investors – What type are you?

I came across this good article at http://www.threetypes.com/philosophy/investor-types.shtml

and wanted to share. It essentially discusses the various types of Investors viz : Savers,
Speculators and Specialists and then goes on to explain how becoming a Specialist, is something
which generates immense wealth over lesser periods of time , but which also requires
tremendous efforts on the part of the investor.
Go ahead and decide which type of investor you are and then invest accordingly. Enjoy
Investing…..
Savers
Savers are those people who spend the majority of their life slowly growing their “nest egg” in order to ensure a
comfortable retirement. Savers explicitly choose not to focus their time on investing or investment strategy; they
either entrust others to dictate their investments (money managers or financial planners) or they simply diversify
their investments across a number of different asset classes (they create “a diversified portfolio”). For those who
create a diversified portfolio, their primary investing strategy is to hedge each of their investments with other “non-
correlated” investments, and ultimately generate a consistent annual return in the range of 3-8% (after adjusting for
inflation). Those who entrust their money to professional money managers generally get the same level of
diversification, and the same 3-8% returns (minus the management fees).
Savers seek low-risk growth of their capital, and in return, are willing to accept a relatively low
rate of return. While there is certainly nothing wrong with striving for consistent returns, what
the Saver is doing is really no different than putting their money in a Certificate of Deposit,
albeit with slightly higher returns. The bulk of Savers are investing for long-term financial
security and retirement. They start saving in their 20’s and 30’s by putting money in 401(k)
accounts, mutual funds, and other diversified investments, and in 30 or 40 years, they have
enough to retire on.
Savers rely in a single force to grow their capital: time. Because their rate of return is generally
consistent, a Saver’s primary mechanism to achieve wealth is to invest and wait. In fact, Savers
often use The Rule of 72 to calculate long-term investment growth and plan their retirement.
While passive investing is an almost surefire path to a comfortable retirement, it also generally
means 30-50 years of work to get to that point.
Speculators
Unlike Savers, Speculators choose to take control of their investments, and not rely solely on
“time” to get to the point of financial independence. Speculators are happy to forgo the relatively
low returns of a diversified portfolio in order to try to achieve the much higher returns of
targeted investments. Instead of just spreading their money across stock funds, bonds, real estate
funds, and a variety of other asset categories, Speculators are always looking for an investing
edge. Perhaps they get a hot stock tip and try to cash in on the next Google. Or perhaps they hear
about all the real estate investors who have made a bundle flipping houses, so they go out and
buy the first run-down house they see.
Speculators recognize that they can have higher returns than Savers, and are willing to do or try
anything to get those returns. They’re not scared to throw some money in an Options account
and try their hand at derivatives trading; or run out and buy a bunch of inventory from a
wholesaler they know and open up an eBay selling account. Speculators are always looking for
the next great investment; for them, it’s all about being in the right place at the right time, and
taking a chance on getting rich. If today’s investment doesn’t work out, there will always be
another one tomorrow.
While the Speculator recognizes the potential gains from smart investing, he doesn’t always
invest smart. He is very much a gambler, and while sometimes those gambles pay off, often
times they don’t. And just like a gambler, the Active Investor’s biggest rival is the “vigorish,”
the commissions and fees he pays to enter and exit all his investments. While the Speculator may
have enough luck and skill to be a successful investor, he may show little or no profit after
paying brokerage commissions, and other investing fees.
Specialists
The third type of investor is the Specialist. Like the Speculator, the Specialist realizes that there
is a more powerful investing strategy than just diversifying across a range of asset classes. But,
unlike the Speculator, the Specialist understands that the key to successful investing isn’t luck,
“hot tips”, or “being in the right place at the right time”; it’s education and experience. The
Specialist recognizes that investing is no different than any other competitive endeavor — there
will be winners and there will be losers, and the winners will generally be those who are most
prepared.
The Specialist generally picks a single investing area, and becomes an expert in that area. Some
Specialists deal in paper assets, some deal in real estate, and some start businesses. Unlike the
Speculator who looks for the next “hot” investing area and the next hot market, the Specialist can
make money in his chosen investment area during any market — hot, cold, or in-between. The
Specialist knows his investment area inside and out, and instead of just entering and exiting
investments, the Specialist has a plan.
In fact, having a plan is the key difference between the Specialist and either the Saver or the
Speculator. The plan is the blueprint for achieve investment success, and with it, the Specialist
can achieve huge returns with relatively low risk.
So, Investing Types is Correct?
Each of the three investing types clearly has its advantages and disadvantages…
The advantage to being a Saver is that you free to spend your time and energy on things other
than investing, but in return you will wait a long time before you have the opportunity at
financial freedom. Speculators have the opportunity to “hit it big” if they end up at the right
place at the right time, but when they don’t hit it big, they often don’t even see as high of returns
as the Saver. And while being a Specialist Investor requires the most time and effort, the rewards
are the most profound – both in terms of control over income and the opportunity for financial
success.
My 2 cents on this :
Savers Beginner Investors who are short of time should begin as Savers thereby begin investing
in broad vehicles like Exchange Traded funds (ETF’s), Index Funds, Blue Chip Stocks on a
monthly basis using Systematic Investing Planning (SIP) concept.
Speculators You need to understand the Risk Management and Money Management Concepts,
have a grasp on price movements and understanding of Charts, you have to make decisions and
should be independent in your thinking. And above all you should have the necessary emotional
discipline and patience to withstand the roller coaster rides of the markets which are part and
parcel of speculation.
Specialists Becoming a specialist requires a couple of years to grasp the skills in stock picking or
successfully trend trading. In value based investing, Specialists do not diversify, they pick up
undervalued stocks, invest huge sums in these stocks (typically 10-15% of portfolio) , have the
conviction to hold on to the businesses for long periods of time until the market fairly values the
stock before exiting (Sometimes the specialists never have the need to exit because the
businesses keep performing well above the market. Here picking undervalued stocks and doing
this consistently over long periods of time is where the true skills of specialists is tested. (eg:
Value investors Warren Buffett, Phil Fisher, Rakesh Jhunjhunwala, Peter Lynch etc. )
In successful trend Trading, Specialists consistently develop systems and trade systems over
periods of time and identify and ride trends (eg: george soros, W D Gann — famous for Gann
Charts etc.) In either cases , conviction , discipline and patience is what differentiates the
specialists from the speculators and savers.
So go ahead , decide where you want to fit, but start investing as a Saver if you are beginning
investors before going on to become a Speculator or Specialist.
Related post understand the magic of compounding by investing early illustrates the power and
benefit of early investing.

INVESTOR BEHAVIOUR:-

Behavioral Finance: Questioning the Rationality Assumption

Much economic theory is based on the belief that individuals behave in a rational manner and
that all existing information is embedded in the investment process. This assumption is the crux
of the efficient market hypothesis. (To read more on behavioral finance, see Working Through
The Efficient Market Hypothesis.)

But, researchers questioning this assumption have uncovered evidence that rational behavior is
not always as prevalent as we might believe. Behavioral finance attempts to understand and
explain how human emotions influence investors in their decision-making process. You'll be
surprised at what they have found.

The Facts
In 2001 Dalbar, a financial-services research firm, released a study entitled "Quantitative
Analysis of Investor Behavior", which concluded that average investors fail to achieve market-
index returns. It found that in the 17-year period to December 2000, the S&P 500 returned an
average of 16.29% per year, while the typical equity investor achieved only 5.32% for the same
period - a startling 9% difference! It also found that during the same period, the average fixed-
income investor earned only a 6.08% return per year, while the long-term Government Bond
Index reaped 11.83%.

Why does this happen? There are a myriad of possible explanations.

Regret Theory
Fear of regret, or simply regret, theory deals with the emotional reaction people experience after
realizing they've made an error in judgment. Faced with the prospect of selling a stock, investors
become emotionally affected by the price at which they purchased the stock. So, they avoid
selling it as a way to avoid the regret of having made a bad investment, as well as the
embarrassment of reporting a loss. We all hate to be wrong, don't we?

What investors should really ask themselves when contemplating selling a stock is, "What are
the consequences of repeating the same purchase if this security were already liquidated and
would I invest in it again?" If the answer is "no", it's time to sell; otherwise, the result is regret of
buying a losing stock and the regret of not selling when it became clear that a poor investment
decision was made - and a vicious cycle ensues where avoiding regret leads to more regret.

Regret theory can also hold true for investors when they discover that a stock they had
only considered buying has increased in value. Some investors avoid the possibility of feeling
this regret by following the conventional wisdom and buying only stocks that everyone else is
buying, rationalizing their decision with "everyone else is doing it". Oddly enough, many
people feel much less embarrassed about losing money on a popular stock that half the world
owns than about losing on an unknown or unpopular stock.

Mental Accounting
Humans have a tendency to place particular events into mental compartments, and the difference
between these compartments sometimes impacts our behavior more than the events themselves.

Say, for example, you aim to catch a show at the local theater, and tickets are $20 each. When
you get there you realize you've lost a $20 bill. Do you buy a $20 ticket for the show anyway?
Behavior finance has found that roughly 88% of people in this situation would do so. Now, let's
say you paid for the $20 ticket in advance. When you arrive at the door, you realize your ticket is
at home. Would you pay $20 to purchase another? Only 40% of respondents would buy another.
Notice, however, that in both scenarios you're out $40: different scenarios, same amount of
money, different mental compartments. Pretty silly, huh?

An investing example of mental accounting is best illustrated by the hesitation to sell an

investment that once had monstrous gains and now has a modest gain. During an economic boom
and bull market, people get accustomed to healthy, albeit paper, gains. When the
market correction deflates investor's net worth, they're more hesitant to sell at the smaller profit
margin. They create mental compartments for the gains they once had, causing them to wait for
the return of that gainful period.

Prospect/Loss-Aversion Theory
It doesn't take a neurosurgeon to know that people prefer a sure investment return to an uncertain
one - we want to get paid for taking on any extra risk. That's pretty reasonable.
Here's the strange part. Prospect theory suggests people express a different degree of emotion
towards gains than towards losses. Individuals are more stressed by prospective losses than they
are happy from equal gains. An investment advisor won't necessarily get flooded with calls from
her client when she's reported, say, a $500,000 gain in the client's portfolio. But, you can bet that
phone will ring when it posts a $500,000 loss! A loss always appears larger than a gain of equal
size - when it goes deep into our pockets, the value of money changes.

Prospect theory also explains why investors hold onto losing stocks: people often take more risks
to avoid losses than to realize gains. For this reason, investors willingly remain in a risky stock
position, hoping the price will bounce back. Gamblers on a losing streak will behave in a similar
fashion, doubling up bets in a bid to recoup what's already been lost.
So, despite our rational desire to get a return for the risks we take, we tend to value something
we own higher than the price we'd normally be prepared to pay for it.

The loss-aversion theory points to another reason why investors might choose to hold their losers
and sell their winners: they may believe that today's losers may soon outperform today's winners.
Investors often make the mistake of chasing market action by investing in stocks or funds which
garner the most attention. Research shows that money flows into high-performance mutual funds
more rapidly than money flows out from funds that are underperforming.

Anchoring
In the absence of better or new information, investors often assume that the market price is the
correct price. People tend to place too much credence in recent market views, opinions and
events, and mistakenly extrapolate recent trends that differ from historical, long-term averages
and probabilities.

In bull markets, investment decisions are often influenced by price anchors, prices deemed
significant because of their closeness to recent prices. This makes the more distant returns of the
past irrelevant in investors' decisions.

Over-/Under-Reacting
Investors get optimistic when the market goes up, assuming it will continue to do so. Conversely,
investors become extremely pessimistic during downturns. A consequence of anchoring, or
placing too much importance on recent events while ignoring historical data, is an over- or
under-reaction to market events which results in prices falling too much on bad news and rising
too much on good news.

At the peak of optimism, investor greed moves stocks beyond their intrinsic values. When did it
become a rational decision to invest in stock with zero earnings and thus an infinite price-to-
earnings ratio (think dotcom era, circa year 2000)?

Extreme cases of over- or under-reaction to market events may lead to market panics and
crashes. (For more reading on the subject, see The Greatest Market Crashes.)

Overconfidence
People generally rate themselves as being above average in their abilities. They also overestimate
the precision of their knowledge and their knowledge relative to others. Many investors
believe they can consistently time the market. But in reality there's an overwhelming amount of
evidence that proves otherwise. Overconfidence results in excess trades, with trading costs
denting profits.

Counterviews: Is Irrational Behavior an Anomaly?

As we mentioned earlier, behavioral finance theories directly conflict with traditional finance
academics. Each camp attempts to explain the behavior of investors and the implications of that
behavior. So, who's right?

The theory that most overtly opposes behavioral finance is the efficient market hypothesis
(EMH), associated with Eugene Fama (Univ. Chicago) & Ken French (MIT). Their theory that
market prices efficiently incorporate all available information depends on the premise that
investors are rational. EMH proponents argue that events like those dealt with in behavioral
finance are just short-term anomalies, or chance results, and that over the long term these
anomalies disappear with a return to market efficiency.

Thus, there may not be enough evidence to suggest that market efficiency should be abandoned
since empirical evidence shows that markets tend to correct themselves over the long term. In his
book "Against the Gods: The Remarkable Story of Risk" (1996), Peter Bernstein makes a good
point about what's at stake in the debate:
"While it is important to understand that the market doesn't work the way classical models think
- there is a lot of evidence of herding, the behavioral finance concept of investors irrationally
following the same course of action - but I don't know what you can do with that information to
manage money. I remain unconvinced anyone is consistently making money out of it."

Conclusion
Behavioral finance certainly reflects some of the attitudes embedded in the investment
system. Behaviorists will argue that investors often behave irrationally, producing inefficient
markets and mispriced securities - not to mention opportunities to make money. That may be true
for an instant, but consistently uncovering these inefficiencies is a challenge. Questions
remain over whether these behavioral finance theories can be used to manage your money
effectively and economically. (To continue reading on behavioral finance, see Taking A Chance
On Behavioral Finance.)

That said, investors can be their own worst enemies. Trying to out-guess the market doesn't pay
off over the long term. In fact, it often results in quirky, irrational behavior, not to mention a dent
in your wealth. Implementing a strategy that is well thought out and sticking to it may help you
avoid many of these common investing mistakes.

by Cathy Pareto,CFP, AIF (Contact Author | Biography)

Cathy Pareto, MBA, CFP, AIF, is the founder and president of Cathy Pareto & Associates, Inc.,
Investment Management and Financial Planning. Pareto has more than 12 years of experience in
the financial services industry. After a 10-year engagement as a senior financial advisor with a
large investment management firm, Cathy decided to pursue her passion for helping individuals,
families, small businesses, young executives, and other professionals with substantial investable
assets, but who fall below most large investment advisory firms' account minimum requirements.

THREE INVESTORS:-

The Three Types of Investors

As should be obvious from my personal investing journey, I progressed through multiple stages
of financial wisdom before figuring out the key to attaining wealth:
For the first several years, I hoarded cash and diversified my investments to ensure a consistent
return on my capital, regardless of how small that return might have been. Once I realized that I
wasn’t going to be able to achieve my financial dreams strictly through diversification, I spent a
couple years chasing the next big investment craze, and looking for a big opportunity to strike it
rich. Unfortunately, there was no “magic bullet” that allowed to get-rich-quick, and once the
market took a down-turn, I found myself back at square one. Finally, I realized that my key to
financial independence was to focus my energies on a single investing area, and devote my time
and energy to creating and fulfilling my strategic investing vision.
In my experience, most successful investors go through these same stages before they become
successful as well. Some, like me, slowly evolve from one stage to another. Others are luckier,
and quickly find their investing niche, bypassing the intermediate stages of growth. And others
forever bounce back and forth between stages, hoping to find the “golden ticket” to success.
While people have been successful at each stage of investing, one stage stands out for those who
aspire to attain wealth. And by understanding the different stages, you can better target the type
of investor you want to be.
The following are the three types of investors most commonly seen:
Savers
Savers are those people who spend the majority of their life slowly growing their “nest egg” in
order to ensure a comfortable retirement. Savers explicitly choose not to focus their time on
investing or investment strategy; they either entrust others to dictate their investments (money
managers or financial planners) or they simply diversify their investments across a number of
different asset classes (they create “a diversified portfolio”). For those who create a diversified
portfolio, their primary investing strategy is to hedge each of their investments with other “non-
correlated” investments, and ultimately generate a consistent annual return in the range of 3-8%
(after adjusting for inflation). Those who entrust their money to professional money managers
generally get the same level of diversification, and the same 3-8% returns (minus the
management fees).
Savers seek low-risk growth of their capital, and in return, are willing to accept a relatively low
rate of return. While there is certainly nothing wrong with striving for consistent returns, what
the Saver is doing is really no different than putting their money in a Certificate of Deposit,
albeit with slightly higher returns. The bulk of Savers are investing for long-term financial
security and retirement. They start saving in their 20’s and 30’s by putting money in 401(k)
accounts, mutual funds, and other diversified investments, and in 30 or 40 years, they have
enough to retire on.
Savers rely in a single force to grow their capital: time. Because their rate of return is generally
consistent, a Saver’s primary mechanism to achieve wealth is to invest and wait. In fact, Savers
often use The Rule of 72 to calculate long-term investment growth and plan their retirement.
While passive investing is an almost surefire path to a comfortable retirement, it also generally
means 30-50 years of work to get to that point.

Speculators
Unlike Savers, Speculators choose to take control of their investments, and not rely solely on
“time” to get to the point of financial independence. Speculators are happy to forgo the relatively
low returns of a diversified portfolio in order to try to achieve the much higher returns of
targeted investments. Instead of just spreading their money across stock funds, bonds, real estate
funds, and a variety of other asset categories, Speculators are always looking for an investing
edge. Perhaps they get a hot stock tip and try to cash in on the next Google. Or perhaps they hear
about all the real estate investors who have made a bundle flipping houses, so they go out and
buy the first run-down house they see.
Speculators recognize that they can have higher returns than Savers, and are willing to do or try
anything to get those returns. They’re not scared to throw some money in an Options account
and try their hand at derivatives trading; or run out and buy a bunch of inventory from a
wholesaler they know and open up an eBay selling account. Speculators are always looking for
the next great investment; for them, it’s all about being in the right place at the right time, and
taking a chance on getting rich. If today’s investment doesn’t work out, there will always be
another one tomorrow.
While the Speculator recognizes the potential gains from smart investing, he doesn’t always
invest smart. He is very much a gambler, and while sometimes those gambles pay off, often
times they don’t. And just like a gambler, the Active Investor’s biggest rival is the “vigorish,”
the commissions and fees he pays to enter and exit all his investments. While the Speculator may
have enough luck and skill to be a successful investor, he may show little or no profit after
paying brokerage commissions, and other investing fees.
Specialists
The third type of investor is the Specialist. Like the Speculator, the Specialist realizes that there
is a more powerful investing strategy than just diversifying across a range of asset classes. But,
unlike the Speculator, the Specialist understands that the key to successful investing isn’t luck,
“hot tips”, or “being in the right place at the right time”; it’s education and experience. The
Specialist recognizes that investing is no different than any other competitive endeavor — there
will be winners and there will be losers, and the winners will generally be those who are most
prepared.
The Specialist generally picks a single investing area, and becomes an expert in that area. Some
Specialists deal in paper assets, some deal in real estate, and some start businesses. Unlike the
Speculator who looks for the next “hot” investing area and the next hot market, the Specialist can
make money in his chosen investment area during any market — hot, cold, or in-between. The
Specialist knows his investment area inside and out, and instead of just entering and exiting
investments, the Specialist has a plan.
In fact, having a plan is the key difference between the Specialist and either the Saver or the
Speculator. The plan is the blueprint for achieve investment success, and with it, the Specialist
can achieve huge returns with relatively low risk.
So, Investing Types is Correct?
Each of the three investing types clearly has its advantages and disadvantages...
The advantage to being a Saver is that you free to spend your time and energy on things other
than investing, but in return you will wait a long time before you have the opportunity at
financial freedom. Speculators have the opportunity to “hit it big” if they end up at the right
place at the right time, but when they don’t hit it big, they often don’t even see as high of returns
as the Saver. And while being a Specialist Investor requires the most time and effort, the rewards
are the most profound – both in terms of control over income and the opportunity for financial
success.
Now that you understand the various types of investors, it’s important for you to understand the
“vehicles” used by these investors to generate their wealth...these are the three types of income...
ARBITRAGE:-

What Does Arbitrage Mean?

The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It
is a trade that profits by exploiting price differences of identical or similar financial instruments,
on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it
provides a mechanism to ensure prices do not deviate substantially from fair value for long
periods of time.

Investopedia explains Arbitrage

Given the advancement in technology it has become extremely difficult to profit from mispricing
in the market. Many traders have computerized trading systems set to monitor fluctuations in
similar financial instruments. Any inefficient pricing setups are usually acted upon quickly and
the opportunity is often eliminated in a matter of seconds.