By Harrison Heaton
When associating these two terms, it might be hard to identify the differences on the surface. Yet, when you dive deeper into the logistics and method of madness behind each of the concepts, a fine line is clearly drawn that differentiates the two. As Benjamin Graham, the author of “The Intelligent Investor” puts it, “An investment operation is one which, on thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
I want to start off with the concept of speculation and the underlying ideology behind such a term. Speculation is the utilization of putting some X amount of your capital into a financial opportunity or investment in the pursuit of high returns that have a higher probability of failure correlated with them. While speculators try to make educated and informed decisions based on the market, there is an inherent and baked in level of risk that far succeeds some acts of investing. The time horizon of speculation is rather short, often having the transactions and management all fall short of the 1 year mark. Speculation is often looked at as trying to make money fast in the hope that something will happen to the financial instrument the speculator got into, however more time than not this does not work in their favor. I think this is best illustrated by an example. When looking at companies to put your money into, a new aerospace company has been in the talks of launching a new rocket within the next year. Yet, they also have capital risk and have a fear of going bankrupt. Speculative investors might believe in the company enough to put large amounts of capital into the stock and receive a high return due to the stock price going up if a successful launch happens. However, on the other end of the speculative investment, if the highly complicated launch fails or the company goes bankrupt before the launch, the stock price would decrease dramatically losing the investor money. This is where the root definition of speculation comes into play. The formation of a theory without firm evidence. These investors are hoping something works out based on multiple factors like talk through the media, word from the company management, hope of landing the next big fish, etc. Often Times than not personal opinion is based on the aggressive mindset of traders, and market psychology.
This is more and more prevalent in today's society with the cryptocurrency market, in which many of these funds are listed on stock market exchanges and are becoming more available for the everyday investor. A lot of people “investing” in these cryptos don’t completely understand what they are getting into when they push the buy button, but since it is the new wave everyone is hoping for, people put their money into it. They seek the 1000x returns in less than a year that has been happening through the course of crypto's history, but there is no way to determine this return, people just hope that it happens again. Day traders hoping to enter a large position low and sell high the same day, or swing trades hoping their position becomes more favorable with a week by week time horizon are examples of speculative traders.
Now, reading that you probably could apply some of those principles to the traditional investors, however there are some key differences in speculation vs investing within the stock market. Like mentioned above, time horizons are a huge differentiator. Many investors emphasize value investing in which they look at well established companies, with favorable earning reports, liquidity ratios, terrific management, etc. and invest in the research and performance backed companies for years and years. Investors hope to receive profits by taking on average to below-average risk on investments that are analyzed on a deeper level, whereas opinion is strong in speculative investing. Long-term holdings with greater investment qualities like dividend offerings, appreciation, and previous history of success is what separates speculation from investing. Yes, you might be saying to yourself, can't speculative investors do all this research like traditional investors do just on a shorter term and the answer is yes. But when you have a shorter time horizon it is much much harder to predict short term success of a company or predict what it might do in the span of a day or week. Negative externalities such as breaking news headlines, death of a CEO, false accusations that develop into rumors, can affect the stock price on a day by day basis, whereas longer term holdings are less vulnerable to this.
Fundamental analysis and research are necessary when it comes to investing, but the second you make a trade without doing such a thing you are now speculative investing. Evaluation each financial instrument, the company and all its characteristics, the sectors of market the company is in, the dividend payout rate, dividend growth rate, the market as a whole, and how sensitive it is to changes at the FED level, are all considerations that need to be taken to ensure a sound investment that has a greater probability of success.
Now, probably the biggest difference between these two concepts are the classes of financial instruments that each fall into. Some speculative instruments include the crypto market, options trading, futures, forex, foreign currencies, and start-up companies all have an innate higher risk to them that may result in a loss of money or a gold rush. However, investing incorporates assets such as the stock market, mutual funds, U.S treasury bonds, and real estate. But in the stock market specifically it all boils down to time horizons, research performed, and the company you are getting involved in.
Speculation can work out. Don't get me wrong, a lot of people have made enormous amounts of money doing day trading, swing trades, getting involved in early companies or crypto coins. However, at the same time people have lost extreme amounts of money doing the same tactics. If you want reliability, confidence in your investment picks and a less stressful portfolio that is not based on volatile daily changes then traditional investing is the concept to go for and it has been proven to beat out the people that try to make big money quickly. I believe investing and speculation investing have a very fine line in between them, but the mindset, intentions, research, and choices where you put your money make all the difference.
Work Cited
Nguyen, Joseph. “What Is the Difference between Investing and Speculating?” Investopedia, Investopedia, 19 May 2021, https://www.investopedia.com/ask/answers/09/difference-between-investing-speculating.asp.
SoFi. “The Difference between Speculation vs. Investing.” SoFi, SoFi, 11 July 2021, https://www.sofi.com/learn/content/speculation-vs-investing/.
“Speculation Definition & Meaning.” Merriam-Webster, Merriam-Webster, https://www.merriam-webster.com/dictionary/speculation.
Hartono, Yohanes Yopie. “Chapter 1 'The Intelligent Investor': Investment versus Speculation.” LinkedIn, LinkedIn, 3 Mar. 2021, https://www.linkedin.com/pulse/chapter-1-intelligent-investor-investment-versus-hartono/.
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