In the market today everybody calls themselves investors. No retail investor like to be called a trader or speculator irrespective of what they actually do.
Knowing the difference between investment and speculation is vital. It is vital to your plan for long term capital protection and short term early gains.
The distinction according to me depends largely on the person doing the activity. It is like the saying “Beauty is in the eye of the viewer, Perception is in the mind of the investor“. It is what you decide that determines if its investing or speculation.
I know a client who bought futures of Axis Bank around Rs.310 (after considering recent split) in mid 2013. He ended up in huge losses by September when it traded at Rs.152 and thought it was big mistake. But he did not book his losses.
He kept rolling over and over for almost 15 months. Now we all know that Axis Bank almost doubled and trades around Rs.390 in mid 2014. He still has his position open hoping to make a big profit in future.
This behavior is possible only if you have cash and patience to ride out the fall. It is a classic situation where a speculation is turning out to be an investment.
Investment vs speculation
• An ideal investment is purchasing something that is safe from major loss. It is well established and based on thorough factual analysis. It has more chance of gaining value than losing value if owned for over three or more years.
• A speculation is the purchase of something that is unpredictably safe or risky. You think it will gain fast and can resell for a quick profit. You know clearly that it can end both ways and you’re prepared for both outcomes.
Considering these definitions of investing and speculation, a stock or real estate can be both of them. As said it depends on what you plan to do with it.
Suppose your plan is to short sell Banking stocks on expectations of rise in interest rates. If all goes well you can double your profit or more when you sell out. This is pure speculation. There is also a chance that the RBI Governor may leave them unchanged and SBI, Axis Bank actually gains. Then you lose capital which is other side of speculation.
Again a good low cost stock can be an investment. Suppose you hear that stock of a small manufacturing company sells for Rs.15 which many consider a penny stock.You learn that the company plans to launch a product which looks promising. The decision to put Rs.20000 into that stock can be an investment if you plan to pass up any chance to make a quick gain.
You also plan to hold on until the product becomes a super hit. So the company launches the product and in 5 years has major market share. You will reap great profit from such investments.
For tips on How to choose stocks for long term investment, read this post.
Is speculation bad ?
Every person I meet does not like to call himself an speculator. There is confusion about this because people have an impression that speculation is bad and investment is good. Nothing can be farther from truth.
Rakesh Jhunjunwala once replied to an investor who tried to portray speculation in bad light. He said “You say speculating is bad.I was poor when I started . Investing karne ke liye Paisa kaun dhega? Tera Baap?. I made sensible trades and put that into investments. ”
The financial world has its fair share poor investors and rich speculators. It just depends on the decisions you make. Investors who take poor risks do badly. Speculators who take well-calculated risks do well.
Note: First you must truly have the knowledge to estimate whether it’s a well-calculated risk. You will learn only from experience.
I hope you always recognize that everything carries some risk. There is nothing that is absolutely safe and can be sold for profit when you desire. Some things are certain to be worth more in future. But they may have erratic periods when their prices fluctuate.
Must Read: Top 10 tips for long term success in stocks
Also read on Investing and speculating using Minsky criteria.
Weighing risk vs reward in investing and speculating
You need to always weigh the degree of risk versus the possible rewards. Anyone who can repeatedly utilize situations where potential reward is higher than risk will profit.
This is on assumption that he has the resources to ride out any reasonable number of set backs until the favorable odds begin to work in his benefit just like my client did.
So always decide if you’re investing or speculating before making a purchase. Also before speculating, decide if you have the cash and mindset to accept unfavorable results.
Else take the tried and tested route of investing in great companies at reasonable prices. Do it by yourself or starting an SIP in a good mutual fund.
So, are you an investor or speculator?. Tell me about your experiences where you faced similar dilemmas in comment section. Share this if you liked the post on Investment vs Speculation.