Introduction
An Investor and a speculator are broadly two types of participants in the stock market. The basic difference between the two is the approach they look at the assets and equities. An investor looks at the stock market like a business and a speculator looks it like a gamble.
From the book The Intelligent Investor, author Graham defines an investment in 3 major things:
- Thorough analysis
- Protection of principal amount / losses
- Not aspiring for extra ordinary returns
Also read: Chapter 8 Of The Intelligent Investor Explained For Beginners to know more about the concept of investing and market fluctuations.
What is an investment
An investment is an approach to buy assets or equities in order to generate a decent return on the principal capital which was used to buy those assets. The idea of investing is to protect one from the depreciating value of money due to inflation, get sizable return on the surplus capital and generate an alternate source of revenue.
As per the definition of Investopedia “An investment is an asset or item acquired with the goal of generating income or appreciation. Appreciation refers to an increase in the value of an asset over time. When an individual purchases a good as an investment, the intent is not to consume the good but rather to use it in the future to create wealth”
As you know, inflation reduces the purchasing power of currency over time. Hence, it is important for a person to consider investing a portion of their earnings in assets and equities.
What is speculation
Speculation is a way one looks at opportunities for buying and selling of assets over a short duration of time. A speculation is nothing but placing a bet on assets. If the bet is in your favor, you make money. If the bet gets against your call, you lose.
Imagine playing Roulette in a casino. People bet on numbers based on the probability of success. There is no guarantee other than luck, one might win the game. Also, in speculation, there might not be any consistency in winning those bets.
Difference between investment and speculation
The approach about market
An investor looks at market like a business. Like any other business, one cannot become a millionaire overnight. Thus an investment requires a certain duration to generate returns over a period of time.
On the other hand, in a speculation, one targets for extraordinary returns. A speculator has a goal to only generate unlimited returns over a very short period of time, even if it costs him the entire capital to do so.
Strategic planning
An investment requires a set of planning. One needs to understand the fundamentals of an asset before buying / selling them. An investor also understands the intrinsic value of an asset and then tries to price the investment and procure it at a bargain
Speculation does not necessarily require any thorough planning. A speculator only ties to time the market with a major probability in their favor.
Study and research
An investor studies an asset, its past performance, the probable returns in the future and tries to predict a strategic return for oneself. An investment is a slow process. One needs to have an ample amount of patience for creating wealth from investment.
A speculation does not require any form of study or research. Speculation is more like gambling. One takes a shot and only hope that it turns out in their favor.
Risk mitigation
An investor tries to mitigate or lower their risk by purchasing assets at the right valuations. If the price of those assets goes down, an investor is certain about their decision and may wait for the right time to bounce back.
A speculation, on the other hand is highly risky. A speculation can either be in your favor or against, there is no in between. A speculator takes a high amount of risk to take benefit of the returns if the view is in line with their rule.
Stability of returns
Investors tend to look for more stability. An asset fetching a return of 12 – 15% can be considered a good investment. The CAGR (Compound Annual Growth Rate) of Warren Buffett is 22% and he is has made billions with such return.
A speculation may not have any stability. One may double their just double their capital on a single trade or lose the entire capital. One cannot get the same return for a long duration of time.
Value vs Price
An investor is interested in the value of an asset before making an investment. A speculator, on the other hand only plays on the timing of the price movements of those assets.
For example, during the wedding season, a speculator may buy Gold Bonds, thinking that the price of the Gold may shoot up due to the wedding season. On the other hand, an investor will purchase Gold when the equity markets are high and he wants to diversify his portfolio to safeguard the profits.
Buying of Gold in case 1 is speculation based on the prediction on price movement, and in case 2 it is considered as investment for bagging Gold at good valuations.
Are all speculations bad?
I wouldn’t say all speculations are bad. There have been instances where a speculation with high probability of winning that has worked for many people. Specially during the times of COVID-19 pandemic. During the time of global lock down, many businesses were shut. It might be a good speculation to trade to short the market during those hours and make some profits out of it.
Why should one try to take the investment approach?
In my opinion, investment is the best way for looking at stock market equity. One needs to understand the power of compounding. Investing shows consistency and stability in generating returns. There are high chances for a person to be an investor and generate wealth, rather than being a speculator.
Conclusion
Sometimes people get mislead between investment and speculation. People think that they are investing in Assets and Equities, when they are actually speculating. Always remember the basic definition of Investment as mentioned above this blog post. Everything other than that is mere speculation.