Roger Wohlner* says that while investing and speculating are not mutually exclusive, there are some important differences.
Photo: Lorenzo Cafaro
Investing and speculating denote two different approaches to growing one’s money.
There are a number of differences in these two approaches.
What is investing?
Investing can mean a lot of different things.
Investments can be made in time to get a business venture off the ground.
More commonly, investing means putting money into a number of investment vehicles as part of a long-term strategy to build your wealth.
In that context, investing usually involves a strategy including what types of investments to make and in what proportion.
These investments are often in some combination of stocks, bonds and cash.
Investing is generally a longer-term proposition.
Investing in superannuation is an excellent example of long-term investing.
Investing can offer returns from the appreciation of the assets that you have invested in over time.
Some stocks might throw off dividends as well, which add to the overall return on your investment.
Investing can entail building a portfolio of investments.
This might mean holding the stocks of several companies, mutual funds, exchange-traded funds (ETFs), bonds, cash-equivalents or some combination of any or all of these.
An investor may also invest in alternative assets such as private equity, crowdfunding investments, hedge funds, commodities and futures or precious metals among a host of others.
What is speculating?
In the context of investing, speculating is akin to taking a “flyer”.
Speculators often make generally short-term investments in stocks or other investment vehicles with the idea of making a quick profit from a price change either up or down.
Speculative investments can also be made into a business venture as well.
A speculative trade can pan out and a nice profit can be made.
All too often, however, speculative investments don’t pan out and investors lose money on the deal.
This is often a function of the risk involved in these speculative options.
This isn’t to say those who choose speculative investments don’t put in any thought before committing their dollars.
They may often be wholly aware of the potential risk involved but choose to go ahead due to their hope the venture can pan out, and if it does, they will realise a handsome return.
Some examples of speculating in the investing arena could include:
- Futures contracts. This is a means for traders to speculate upon the price movement of an underlying commodity, raw material or financial instrument. The contract can be settled in cash or in delivery of the underlying commodity in some cases. Unless hedged, gains and losses can vary widely.
- Options, puts and calls. Options provide the right to buy or sell shares of stock at a specified price for a specified period. Options also trade in their own right. An investor may have a feeling about the direction of a particular stock, but they can be wrong.
- Short selling means that an investor borrows shares of stock from a broker, which they in turn sell. The expectation is that the price will go down and they will go into the market and replace the borrowed shares with shares purchased at a lower price than the price when borrowed. This is great when it works as planned, but the short seller can be subject to huge losses.
- Inverse and leveraged ETFs. There are a growing number of ETFs available that track an index and will use leverage to multiply the daily price movement by two or three times. Likewise, with inverse ETFs, they will multiply the movement of the underlying index to the downside. These are much like holding a short position, only with the daily price movement magnified by two or three times. So, if the index moves up 2 per cent for the day and you hold a 3x inverse ETF, you would lose roughly 6 per cent for the day. This works the other way as well, if your leveraged or inverse ETF is on the right side of the trade your gains are magnified.
- Other vehicles include Bitcoin, Ethereum, and other cryptocurrencies. The opportunities to profit are great, but so is the risk of outsize losses.
Investing versus speculating: Key differences
Some people might view investing versus speculating a bit differently, but here are some of the key differences:
Time horizon
Investors will generally have a longer time horizon compared with speculators.
Investors tend to invest with a plan and select investments that will help them fulfil that plan.
Speculators are generally looking for a quicker payout.
Risk
Speculating usually involves greater risks than investing, but this isn’t to say investing is always a low-risk proposition.
Rather, those who speculate tend to be looking for a larger and quicker payout than long-term investors.
The road to these types of higher payouts tends to involve riskier vehicles.
This might be the use of financial derivatives, options, futures and similar financial instruments.
Investors will tend towards more traditional financial instruments like stocks, bonds, ETFs and mutual funds.
The decision process
This is a bit of a generalisation, but investors tend to take a more basic fundamental approach.
Things like asset allocation and fundamental analysis of the investments chosen for their portfolio are common thought processes among investors.
Speculators, on the other hand, might look more at trends, market or investor psychology and related factors in choosing where to put their money.
They are hoping to capitalise on these factors for a quick profit.
Not mutually exclusive
Investing and speculating are not always an either/or proposition.
The same person can be both an investor and a speculator.
They can still take a portion of their investible assets and put that money into more speculative vehicles.
* Roger Wohlner is a financial and business writer. He tweets at @rwohlner.
This article first appeared at www.thestreet.com.
