The Differences Between Speculating And Investing

 

Source: motifinvesting.com

 

Every field has its jargon. This is not a way to exclude outsiders from the discussion, but simply how language has evolved to deal with concepts that can’t adequately be described using existing terms. Just as “profit” and “return” aren’t the same thing, investing and speculating are subtly different activities.

Essentially, investing is simply more conservative than speculating. There’s no definite line separating the two, and the same investor may follow a strategy incorporating aspects of both. The essential difference is that investing is most concerned with securing the value of the principal, while speculating means being willing to run greater risks, betting that the investor’s superior knowledge, market access or system will be enough to “beat the market” and generate returns that others can’t match.

 

Investing

Source: creatingwealthyoung.com

 

Buying publicly traded equities clearly does not absolutely guarantee that an investor will get the sum originally invested back out. There’s a high probability of this happening, assuming that he buys a variety of solid stocks spread over several industries and is willing to wait as long as it takes, but this has no guarantee. An investor who bought a portfolio that tracked the Dow Jones Industrial index in 1966 would have had to wait until 1983 or so before seeing any significant returns, with several dips in between. Taking inflation into account changes this date to 1995 or thereabouts.

 

Clearly, investing in the stock market exclusively is not enough to keep an egg nest safe, never mind build one up. An investor, as opposed to a speculator, should have a horizon that ultimately stretches up to the time he retires and should get out of volatile instruments altogether. Regardless of how rosy things look at the moment, things could change a lot over the course of 12 months or a decade. Think of the oil price for an example. The biofuel used to be seen as a star investment (for all the wrong reasons, though that’s a subject for another day), but it’s not looking so good right now. Fringe investments aside, every industry from pharmaceuticals to transport is exposed to changes in the cost of crude.

 

For this reason, responsible investors diversify their portfolios not only among different stocks and industries but into other instruments as well. Government bonds (U.S. T bills as well as foreign), money market funds and bank products all qualify. To illustrate, and leaving the issue of inflation aside, suppose you had $1 million invested in the stock market at the time of the 2008 crash. At the lowest point, you would have had $600,000 left. This would not have been too bad if you could wait a few years more but would have been catastrophic if you wanted to retire at this point. Any shares sold in a depressed market would reduce the number of losses that could have been recouped later.

 

On the other hand, let’s say you had half of your portfolio in something very stable or guaranteed, in other words showing effectively zero growth except over very large timescales, but not affected by whatever happens to be going on in the stock market. In this case, you would have ended up with roughly $800,000 at your disposal. You still would have lost, but not nearly as much.

 

Speculating

Source: linkedin.com

 

Where investing is concerned with the long term and has diversification at its core, speculating narrows its focus to a smaller group of stocks or a shorter period of time. These are short plays; bets on one investor knowing more than the rest of the market. If they pay off, the returns will be much higher than that of a diversified stock portfolio, but if they fail there is no cushioning effect from having stock in other industries.

 

Professional traders may well go heavily into one stock, wait for it to go up over the course of a week, and then take their profits while it’s high before moving on to the next one. However, this blog isn’t aimed at those people. The ordinary individual investor is in no position to bet the farm on, say, what a technical analysis program tells you, or hope that some particular IPO will pan out. Publicly traded shares certainly have their place in a well-designed personal portfolio with a growth focus, but not one at a time, and for months if not years at a time.