What's a good investment

The calendar year of 2005 has passed into history and we are into 2006, you are perhaps musing over many things.
Where the heck did the time go anyway could well be one of them.
Where to invest your money may well be another.

The answer to the first question is equally vexing to me, and about this I have no insight.

The answer to the second is, in some ways, much easier. Why, you should invest your money in good investments, of course.

Now we must decide what constitutes a good investment.

The Compact Oxford English Dictionary calls an investment “a thing worth buying because it may be profitable or useful in the future”. You’ll note that this definitive source presents the word in a tantalizing way, leaving us to discover whether the profit or utility show up in the fullness of time.
That suggests that we might use “good investment” to retrospectively define an investment that proved out to actually be profitable or useful. But it allows us to also consider the future, and call a thing a “good” investment when it not only may be profitable, but when it seems highly likely to be.
Now, I grant you, we have just slid a bit on a slope of uncertain traction. What does “exceptionally likely” mean, after all? But before we explore that, let’s move along the quality continuum in the other direction, and consider a “bad investment”.

If an investment “may”, and a good investment clearly “did”, then it may seem compelling to say that an investment that “didn’t” was a bad investment. But that surely can’t always be the case, since it ignores the distinction between speculation and investment.

If we go back to the Compact OED, it explains that speculation is an investment “in stocks, property, or other ventures in the hope of financial gain but with the risk of loss”. When we glide down the continuum from investment to speculation, in other words, we downgrade “may” to “hope”, and introduce the big but of loss.
In the vernacular, this is not a small distinction. It implies that any speculation may leave you with a great deal less than that with which you started. So a loss need not be the product of a bad investment. It may simply be the sour fruit of a perfectly good speculation which realized its implicit risks.

So losses don’t automatically translate to “bad investment”. But do losses negate the possibility of calling something a “good investment”? That is, if a thing turns out to be neither profitable nor useful, could it still have been a “good investment”? Clearly, yes. We can make investments which hold risks that are exceptionally unlikely to manifest, and suffer when the unlikely occurs.

That doesn’t make the investment “bad”. It would make it, more correctly, a good investment with undesirable consequences. Consider the analogy of a pedestrian struck by a car while walking in a crosswalk. The unfortunate event doesn’t imply that going for walks or using crosswalks are bad practices. In fact, both are excellent practices that generally reduce risk, but may have negative consequences in some very small number of instances.

So what makes an investment or a speculation either “good” or “bad”? If certain actions that produce undesirable negative consequences can still be deemed “good”, then the thing that defines their goodness or badness must be an original condition, and not based on outcome. An investment, in other words, is either good or bad when you make it. This is a critically important point for any investor to understand. It implies that you can make good investments that have undesirable outcomes. And most confusing of all, it implies that investors can make quite bad investments which, despite their folly, can have quite pleasant results.

This last bit is confusing because it is natural to associate an action with its reward. But if the assessment of whether an investment is “good” were to hinge merely on outcome, successful results from insanely risky behaviour would be given the same weight and imitated in the same way as sound first principles. Clearly, this would be a very bad idea. As investors, we must surely be interested in models of success that have shown themselves to be reproducible without recourse to luck and happenstance. In 2006, and in the future, we want to make good investments.

By John Caspar