Investment vs. Speculation in Stocks

“If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring”
-George Soros

Investment beginners, as soon as they get surplus from their income, think to invest in a profitable asset. But after investing in an asset or a stock, they get fascinated by the stock moves and become greedy to make more money, thereby, start speculating. Generally, people speculate thinking that they are investing. But there is a lot of difference between an investment and a speculation.

Speculation is an action, in which money is put into something (securities) that does not promise the safety of initial amount along with the return. It aims at making more profit by taking large exposure of risk in the price fluctuation. In other words, taking large risk to gain money by predicting future prices. Thus, in today’s financial markets transactions are predominantly speculations.

Speculation in stock market:
Speculation is driven by greed rather than good judgment and fear of losing out on an opportunity rather than making right decision. Stock market speculation involves taking a position that will benefit from a certain outcome. Everyone wants to make profits on the stocks they buy, but there is a difference between an investor and a speculator. An investor as a buyer is interested in dividends or coupons & principal amount; and a speculator as a buyer is interested in resale price. Thus, a pure investor will hold his security for longer periods, while the pure speculator sells promptly, if he get what he seeks.

Thus, speculators are the participants who are absolutely willing to accept the fact that they are risking their principal amount. It can be profitable in short term but rarely provides a lifetime of sustainable income or returns. It should be left only to those who can afford to loose everything putting up for the stake. Let us understand more about speculation by distinguishing with the investment.

How is speculation different from investment?
The word investment in finance, is putting money into something with the expectation of high degree of security of both the principal amount as well as the satisfactory returns with in a period of maturity. An investor is someone who carefully analyzes a company, decides exactly what it is worth of, and will not buy the stock unless it is trading at a substantial discount to its intrinsic value.

Whereas speculator is somebody who buys something only because they think someone else will pay more for it in the near future. He is the one who seeks to buy and sell in order to take advantage of market price oscillations – a market momentum on price direction. Lao Tzu, a great philosopher says that, “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge”.

Generally, speculator purchases with short-term focus, thinking somebody will purchase from him at higher price. He is not interested to wait for dividends or for the company to start operating at better efficiency, in fact he has never thought of dividends while purchasing stocks. Speculation is like prediction without any logic, as the speculator does not have or cares about knowledge of the business, its profitability or credibility of management.

There is a big difference in investing and speculating. Benjamin Graham, the father of ‘value investing’, did an excellent job, by explaining the difference in his book, “The Intelligent Investor”. He says that, “An investment operation is one, which upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting this requirement are speculative.”

The author believes that speculators are people guessing future prices while investors focus on the underlying asset, knowing that future prices are tied closely to the economic performance of the asset. If they are correct, it would appear that, much of the activity that dominates the financial markets today is speculation, not investing.

People speculate thinking they are investing:
According to Graham, speculation is not wrong, but entirely different ball game and should not be confused with the investment. He says, speculation is neither illegal nor immoral, but there is an intelligent speculation as there is an intelligent investment. There are many ways how people take speculation in an unintelligent manner. Of these the foremost are:

Speculating when you think you are investing.
Speculating seriously when you lack proper knowledge and skill for it.

Risking more money in speculation.
Most often, speculators do not go for good stocks. They rather prefer speculative or penny stocks which carry a great deal of risk in terms of low probability of higher gains, and high probability of declining in value. So, investor do not buy these stocks as he understands the risk, whereas, speculator finds an unreasonable opportunity in profiting here. As fools rush in where angels fear to tread.

Speculation is always fascinating, and it can be a lot of fun when you are ahead of the game. If you want to try your luck, put aside a portion – the smaller, the better amount of your capital as a separate fund for this purpose. Do not add money for this account just because the market has gone up and profits are rolling in. Never mingle your speculative and investment operations in any part of your thinking.

Risk involved in speculation:
Speculators are ready to lose capital for higher gains. They are constantly looking at the future and conserving resources which they believe are becoming more valuable. Since no one can predict the future with full confidence, speculators unnecessarily take risks. And when a speculator misjudges the future, he moves resources from periods when they are worth more to the periods when they are worth less. So, if a speculator makes a mistake he is soon left without the finances to continue speculating.

Moreover, speculation is like a territory in which the big money is made and also lost. It is not an easy task to make money. However, it is easy to spend money in anticipation of higher returns. So the person without knowing the future prices, will speculate, driven by greed. Everybody remembers one guy who made money. But, the remaining 99, who have lost money lead a living hell silently. If luck is in his direction he will be the winner in his job, if not, the person loses everything for speculating. “Never test the depth of the river with both the feet” says Warren Buffett on taking risks.

You can speculate only when you attempt to beat the others in making higher returns. It needs much knowledge and research in handling riskier investment decisions to get successful in speculation. Remember, half knowledge is dangerous. So, it is always better to go for an investment option where the risks are mostly less, when compared to speculation.

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