Financial markets, equity markets specifically, attract many types of participants. Participants meaning people willing to buy or sell financial securities in the attempt to generate a profit. It is difficult, if not impossible, to identify motives, yet every trade has its intent. Generally, participants can be grouped into investors and speculators. The ebb and flow of the market can be influenced by either at any given time.
It can be difficult to distinguish investing from speculating as they appear to share similar modes and methods, but a closer look reveals a difference. Investing is when an asset is purchased with an intention of holding it for a long-term period to generate income and/or seek appreciation over the full period. Speculation can be considered a more risk-based transaction where the sole purpose is to make profit on that transaction.
Although financial markets are the focus, these definitions can be transferred to other domains. For example, real estate can be purchased with either intent; invest over a period of time to garner income and/or appreciation or flip the property. The first is an investment activity while the second is speculative.
To further the differences, investing and speculation require risk taking, yet the risk profiles are very different. Investing incorporates reasonable or appropriate risk to achieve targeted returns. Think of a well-diversified portfolio based on academic research, capital market analysis and fundamental due diligence. Speculation requires extreme risk with an “all or none” payoff. Think rolling the dice in Las Vegas.
Unfortunately, the stock market can be utilized as a casino. With the advent of low or no cost trading, instantaneous trade execution and internet connectivity, the barriers to trading are effectively gone. Lower barriers create a double-edged sword scenario, helping keep more money in your pocket while encouraging a moral hazard. I’m sure you’ve seen company advertisements viewing a stock chart, placing a trade and relaxing in a hammock with a Mai Tai. Reality is far from the truth. Investing requires data driven analytical thought while speculation requires submitting a trade. Those commercials don’t seem like real investing.
Investing for wealth creation and preservation can be considered monotonous, like watching paint dry. Whereas speculating can offer heart pumping excitement. Isn’t that what Las Vegas preys on to generate revenue and build those fancy hotel/casino/entertainment venues? If you find yourself looking for the big payoff, you may have slipped into a speculation mode without knowing it. We all crave to some excitement, but it is advised not to couple play money with serious money.
It could be said that all investments are speculation at some level, but all speculations are not necessarily investments. Capital market research, fundamentals and a long-term outlook could be said that investing is the intent. Looking for a homerun or the excitement of the trade is clearly speculation. Understanding the difference can go a long way toward setting your limits.
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