Knowing the Difference Between Investing and Speculating
As an investor, when you find a good company selling at very undervalued prices, you can make large gains fairly quickly. But in most cases, gains from sensible investments don't happen that fast. It's thrilling when it comes, but even so, it's not quite the same rush as doubling your money in a week or two. Finding those short, fast gainers is the art of speculation.
Most investors don't understand the difference between the two; and many wrongly think speculation is a dirty word. Investing and speculation are both honorable pursuits, but they have different game rules and different perspectives.
It may come as a surprise, but Warren Buffett is a talented speculator. That's what he was doing a few yeras ago when he suddenly amassed a huge position in silver.
So what is the difference between investing and speculating? The obvious difference is in time. Speculations tend to be special opportunity plays that unfold much faster. But not always. Investments tend to pay off more slowly. But, again, not always.
The principal difference between investing and speculating is in the purpose for holding the stock, or bond, or whatever. The goal of investing is an income stream and growing net worth. Investors look at return on equity, the company's profits compared to what investors have put in -- the shareholder equity. That is a measure of how well the managers are building value.
The purpose of a speculation is simply to buy an asset and then sell it to someone else at a profit... and soon. The basis of speculation is the other guy's wants, not the value of the asset.
Speculation is inherently more risky than investing, because you are trying to gauge how someone else will feel about your asset down the road. Very often, speculators don't even care about the existing value or condition of the speculative asset. That increases risk. But in the stock market, you can cut that risk down when you speculate by paying heed to the asset value and making your play at the right time.
There is one other great difference between investing and speculating. Value investing takes a lot of courage. You tend to be going against the crowd if you want to buy a company when it's cheap and sell it when it's popular and the price is up. But, scary as it may be, if you've done your assessment of the company's worth well at the outset, it is the safest form of investing. The price of a well-chosen value stock may bounce around for a while, but you have a very, very high probability of being right within a year's time.
Because investing is safer over the longer run, you can put serious money in your investment choices, be they retirement funds, your nest egg, or the children's college trust. Given time and caution in making sound choices, the risk that you will lose money is quite low.
In speculation, the risk of being wrong in the long run is usually somewhat higher, since you are looking for the immediate trend to pay off. The risk on each choice is higher than with investments, because you are not waiting around for the asset's worth to prevail. You won't be collecting dividends or growing shareholder equity, even though the asset may be capable of both. You are buying in order to sell, and thus, you count on other people's perceptions and moods. You are trying to guess what people will want and how they will react. Thus when you speculate, you need to be prepared to have some trades go wrong, and it is your strategy that keeps you healthy. You need to be sure not to put too much of your kitty on any one trade.
With investments, each trade's quality is most important. With speculation, the strategy is most important. Successful speculators are not all-the-eggs-in-one-basket types. They tend to allocate their money over a few plays so that if one doesn't work out, the extremely good return on another will more than make up for it.
For all but the most daredevil types, speculation is best done with a very small portion of their money. And attitude is extremely important. Certain traits drive successful speculators:
1. They are reasonably well situated with a comfortable investment account that is already on target to meet their retirement and investment goals.
2. They have some extra money they can put out at a higher risk for a much bigger return; some of the best call it their play money.
3. They are cool, if not calm, when a trade seems to be going the wrong way.
4. They are realists who recognize you can't get a stream of 100% or better returns without taking the occasional loss.
As you can see, none of these characteristics eliminates investors from being speculators. But not all investors have the right temperament. A certain degree of cold-bloodness is needed.
Even those of us who are primarily long-suffering, conservative, sensible investors do often get the urge to try a "big one" now and then.
* * * * *
Most investors don't understand the difference between the two; and many wrongly think speculation is a dirty word. Investing and speculation are both honorable pursuits, but they have different game rules and different perspectives.
It may come as a surprise, but Warren Buffett is a talented speculator. That's what he was doing a few yeras ago when he suddenly amassed a huge position in silver.
So what is the difference between investing and speculating? The obvious difference is in time. Speculations tend to be special opportunity plays that unfold much faster. But not always. Investments tend to pay off more slowly. But, again, not always.
The principal difference between investing and speculating is in the purpose for holding the stock, or bond, or whatever. The goal of investing is an income stream and growing net worth. Investors look at return on equity, the company's profits compared to what investors have put in -- the shareholder equity. That is a measure of how well the managers are building value.
The purpose of a speculation is simply to buy an asset and then sell it to someone else at a profit... and soon. The basis of speculation is the other guy's wants, not the value of the asset.
Speculation is inherently more risky than investing, because you are trying to gauge how someone else will feel about your asset down the road. Very often, speculators don't even care about the existing value or condition of the speculative asset. That increases risk. But in the stock market, you can cut that risk down when you speculate by paying heed to the asset value and making your play at the right time.
There is one other great difference between investing and speculating. Value investing takes a lot of courage. You tend to be going against the crowd if you want to buy a company when it's cheap and sell it when it's popular and the price is up. But, scary as it may be, if you've done your assessment of the company's worth well at the outset, it is the safest form of investing. The price of a well-chosen value stock may bounce around for a while, but you have a very, very high probability of being right within a year's time.
Because investing is safer over the longer run, you can put serious money in your investment choices, be they retirement funds, your nest egg, or the children's college trust. Given time and caution in making sound choices, the risk that you will lose money is quite low.
In speculation, the risk of being wrong in the long run is usually somewhat higher, since you are looking for the immediate trend to pay off. The risk on each choice is higher than with investments, because you are not waiting around for the asset's worth to prevail. You won't be collecting dividends or growing shareholder equity, even though the asset may be capable of both. You are buying in order to sell, and thus, you count on other people's perceptions and moods. You are trying to guess what people will want and how they will react. Thus when you speculate, you need to be prepared to have some trades go wrong, and it is your strategy that keeps you healthy. You need to be sure not to put too much of your kitty on any one trade.
With investments, each trade's quality is most important. With speculation, the strategy is most important. Successful speculators are not all-the-eggs-in-one-basket types. They tend to allocate their money over a few plays so that if one doesn't work out, the extremely good return on another will more than make up for it.
For all but the most daredevil types, speculation is best done with a very small portion of their money. And attitude is extremely important. Certain traits drive successful speculators:
1. They are reasonably well situated with a comfortable investment account that is already on target to meet their retirement and investment goals.
2. They have some extra money they can put out at a higher risk for a much bigger return; some of the best call it their play money.
3. They are cool, if not calm, when a trade seems to be going the wrong way.
4. They are realists who recognize you can't get a stream of 100% or better returns without taking the occasional loss.
As you can see, none of these characteristics eliminates investors from being speculators. But not all investors have the right temperament. A certain degree of cold-bloodness is needed.
Even those of us who are primarily long-suffering, conservative, sensible investors do often get the urge to try a "big one" now and then.
* * * * *
posted by Bob Moser at
7:08 PM
0 Comments:
Post a Comment
<< Home