Introduction
You must have heard the term “investment”, often being used loosely. But when it comes to financial parlance, this has a specific meaning. It is usually confused with another similar term: “speculation”.
But why is it even necessary to know the difference? After all, the ultimate purpose is to make money, isn’t it?
If you think so, you might be asking for trouble. The purpose of writing this article is to explain the difference and to suggest a way of how to handle these two.
While investment is a safe way of wealth creation, speculation is fraught with risks and erratic outcomes. Investment is deliberate and well thought out, whereas speculation is aimed to pursue and capture quick rewards.
Definitions
Before moving forward, let’s first define these terms:
Investment
If you buy an asset or a financial product with the intention to hold it for a considerable period and, during this, you want it to earn a regular income for you and may also appreciate in value, it is called investment.
Speculation
If you think a certain asset or a product is currently available for less and, due to some reason, after some time you will be able to sell it for considerably more, and during the period of ownership, it will either not generate any income or, if it does, that is not what you primarily bought it for, you are speculating.
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Comparison
- Investment is a long-term undertaking and speculation implies taking a short-term view.
- The purpose of investment is to own an asset which has some earning ability, whereas speculation only aims to target the difference of buying and selling prices of the asset.
- From investment you can expect regular earnings in the form of rent or dividends etc, as well as capital gain or appreciation in the price of the asset, if and when you sell it. Whereas, from speculation you will only gain some profit when you sell the asset at a price higher than your buying price, if the market permits. There is going to be no earning in between.
- Investment is boring but sure-footed, whereas specualtion is exciting but unclear about the outcome.
- Investment closely focuses on the dynamics of the business it is committing itself to, and keeps the other general factores e.g. inflation, exchange rates, GDP growth, political situation and international factors, etc in the backdrop. On the other hand, speculation is not interested in the detailed business analysis. It takes a shorter approach where it is in search of some opportunities of making quick money. It is not interested in earnings and business growth etc.
- There are some assets e.g. gold, crytocurrencies, forex, commodities and a piece of real estate having no rental value, etc where investment is not possible. If you buy these, you are only speculating.
- There are few other assets where you can invest as well as speculate e.g. stock market and rentable real estate. It depends on the way you approach them and you should expect the outcome accordingly.
Two Ways of Making Money – Which One is Better?
Broadly speaking, there are two ways/ models of making money:
Value creation model (aka investment model).
Information asymmetry model (aka speculation model).
The third one is a hybrid of the above two where one may be deluded to think that he is investing but is actually speculating.
In the value creation model, new money is created (through innovation, hard work, professionalism) which is equitably shared between both participants of the transaction, hence a win-win solution, almost always. In the information asymmetry model, money changes hands only, without any new money being created. Therefore, the whole emphasis is on a win-lose deal which may potentially turn into a lose-win deal, according to the law of averages. One is a sure way of getting rich slowly, the other is a dangerous way of getting rich quickly.
Attributes (style, skills, temperament, strategies) of a speculator (aka trader) and those of an investor are mutually exclusive. A trader is a market person, whereas an investor is a business guy. Investor likes to make safe and realistic assumptions and speculator makes wild and vague ones. An investor works hard in analyzing a business and carefully goes with it, provided he believes in its quality. On the contrary, a speculator only tries to play the price of a business (or a share of it) in his favor. The investor is content with earning as much as the business does over time, whereas the speculator thinks he can earn much more than the business itself, in a relatively short span of time. The speculator assumes, often wrongly, that he can be consistently clever in the market. An investor’s business plan is very simple and a speculator tends to believe something to be simple and doable which is actually very complex and impractical. Therefore, in the long term, an investor’s success probability is significantly more than that of a speculator. A speculator is intelligent but an investor is wise. More often than not, an investor looks like a fool to a speculator.
What to Do?
From the above discussion, you can easily draw relevant conclusions. A few quick tips are:
- Be safe with your money.
- Have a long term plan.
- Always prefer investment over speculation.
- Be content with regular and adequate returns.
- Don’t chase very high returns in a short time. There are some obvious and some hidden risks.
Conclusion
To sum it up, clearly, investment is the way to go. While speculation may give some momentary excitement, it is injurious to your financial health. Refrain from it. Look for some stable and growing businesses and invest in those on a long-term basis.
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