It is not easy to differentiate between investment and speculation (especially for a beginner like me). I am confused all the time. Therefore, I did a little study to clear my doubt.
Once I started the “investigation”, to my surprise, I realized that most of the activities that I am doing everyday fit into the definition of speculation. For example trying to get the most benefit out of something, using shortcuts, trying to exploit certain phenomenons for my own good, jumping into a new activity whenever there seems to be new opportunities, etc. Actually, my life is full of speculations.
The philosophy of investment is about incremental growth. You build on existing things. You are passive but determined. You value more what you have.
The philosophy of speculation is forward looking. You abandon existing things in favor of new things. You are active and getting bored easily. You are constantly searching and trying every possibilities in the hope of getting something better. You value more what you don’t have.
Both sides of a same coin
I think human beings have a mixture of both mindsets (investing and speculative). Or should I say investment and speculation actually complement each other? You cannot separate one from another. Take a case for example. A start-up entrepreneur is the ultimate speculator. Before one could own a business, he/she need to speculate: constantly spotting for new opportunities. When the time comes, he/she jumps right into the trend. He/she could fail or succeed (People say 9 out of 10 start-ups fail. You have to be “lucky” to succeed). If the success lasts long enough, the venture becomes stable and starts to create value. By that time, the entrepreneur becomes an investor who builds on the success and be able to grow his/her business.
The table below summarizes my current understanding about the differences between investment and speculation. However, the table below is biased more to the differences in financial market.
|Profit from||Value generation||Price (psychological) movement|
|Risk||Lower (more stable)||High|
|Market||Take what market offers||Try to steal from others|
|Wasted work||Less (buy and hold)||More (buy and sell and repeat)|
||Long term||Short term high return|
|Complexity||Simple||Complex (to make it works)|
|System||Growing||Zero-sum or less|
In a few sentences,
- investment is all about value creation (e.g. manufacturing products and providing services) while speculation is concerned about price movement. In the latter, you profit purely from price differences. The price movement is mostly influenced by the psychology of the market.
- investment is has lower risk but need more capital to generate more value while speculation is challenging, has higher risk but requires less capital. This explains why most people are speculating because its entry requirement (capital) is lower.
- investment is about getting what market offers you while speculation is about trying to get more by doing more in believing that you can beat the market.
- investment is about doing least since you let the companies or industries work for you by owning a piece of their businesses while speculation is about doing the most (unconsciously) and it is more involving because you keep chasing the price movement. You need to keep buying and selling to generate profit.
- investment is over long term while speculation is of shorter term. For the former, the success rate is highest by maximizing the holding period of a position while for the latter, the success rate will peak if the position is kept open for the shortest time possible. This also explains why people like to speculate because it provides “shortcuts” to wealth.
- investment is about simplicity while speculation is about complexity (timing market, predicting market direction, stock picking…). That’s why most people fail when speculating. It gives a false sense of simplicity.
- investment = growing system (like a living organic creature) while speculation = zero-sum game (one person’s gain is another person’s loss). The former will grow over time while the latter remains constant or shrinking over time.
Are you an investor or a speculator?
You are a speculator if you ask questions like “How’s the market doing? Is it a good time to invest?”, “So which are the stocks/ sectors do you think will do well this year?”.
You are an investor only if you are selecting your options with a realistic expectation of return over a reasonable time period.
The whole concept in two sentences
Investing is to find the chicken that lays golden eggs and keep it. Speculation is to find that chicken and kill it for the golden eggs.
Hopefully, I could make a better decision for my next investment with this new insight / understanding on the differences between investment and speculation.
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