Investing vs. Speculating: What’s the Difference?

5 mins read

Introduction

People navigate the stock markets in a bid to make profits from their investments and trades. These transactions are finalised once investors and traders alike do thorough research or else are willing to take a risk. This article seeks to examine the differences that exist between investing and speculating.

Investing vs. Speculating

When looking at the difference between investment and speculation, investors and traders alike make calculated risks each time they hope to profit from the transactions they conduct while navigating the markets. The amount of risk they incur when they partake in these transactions helps differentiate an investor or trader’s investments from mere speculation.

Simply put, when individuals spend their money with the expectation that this money spent will generate a profit, they are understood to be investing their money. In this scenario, they choose to spend their money after making a reasonable judgement following a thorough investigation that leads them to believe that there is a strong chance of them being successful in their pursuits.

However, if these very individuals choose to spend their money on an undertaking that has been shown to be likely to fail, they are speculating. Here, the success or failure of the money they spent is primarily based on chance or on external events of forces that are beyond their control.

Therefore, the primary difference between investing and speculating relates to the extent to which the investor or trader chooses to take a risk. While low-risk investing takes into account fundamentals and analysis, high-risk speculation is not very different from gambling.

Exploring the World of Investing

Individuals can choose to invest in a given pursuit in several ways. They might invest their money, time or energy in said pursuit. When looking at investments in terms of finances, investing refers to the purchase and sale of securities that may exist as stocks, mutual funds, bonds, exchange traded funds or any other financial products.

When investors invest their money in these assets, they hope to derive a profit or income via an adequate return on their capital by partaking in an average or below-average amount of risk. Income investors derive can be from underlying assets of their investments appreciating in value, receiving the entire amount of capital they originally spent or by periodic dividends.

Investing often requires investors to purchase an asset and hold onto it for a long period of time. In order for an asset to be categorized as a long-term holding, it must be in the investor’s possession for at least one year.

A major aspect of investing is analysis and research pertaining to different assets, patterns, sectors, and trends that prevail in the market. Fundamental or technical analysis may be employed as investment strategies.

Looking at the Realm of Speculations

Speculating involves individuals directing their money towards financial endeavours that are highly likely to fail. While the returns drawn from speculating can prove to be abnormally high, there is a great deal of risk involved owing to which speculating is often compared to gambling. That being said, there exist some differences between the two as unlike gambling, speculations still involve educated decisions on the part of speculators pertaining to the direction of their trades. The inherent speculative risk tethered to such transactions is significant.

Speculators purchase securities with the understanding that they will only hold onto them for a limited time frame prior to selling them. A characteristic trait of several speculators is to move into and out of a position with frequency.

There are downfalls associated with speculative trading which ordinarily arise in instances of inflated expectations of the growth or price of a particular asset class or sector. While their value may rise in the short term, their trading volume is also likely to increase which would lead to a bubble that would ultimately be followed by a crash. Take for instance the dot-com bubble which was followed by the market crashing post-2001.

Speculative traders tend to partake in day trading or operate as swing traders. Day traders derive their name from the fact that they trade with frequency and hold their positions for a day. In contrast, swing traders hold their stance for several weeks in the hope of capitalizing on gains that transpire during this time.

Futures Contracts:

Here, buyers and sellers agree to sell a specific asset keeping in mind a price that is agreed upon by both parties at a predetermined point in time in the future.

Put and Call Options:

In the case of put options, owners of contracts are entitled but not obligated to sell a security at an agreed-upon price keeping in mind a specified time frame. Call options on the other hand permit contract owners to buy underlying assets without being obligated to do so before the contract expires and at an outlined price.

Short Selling:

This involves traders taking a position keeping in mind their speculations on the price of a security dropping in the future.

Concluding Thoughts

Prior to speculating it is important to take a look at your capacity for risk and your financial goals. Owing to the fact that investing involves ample amounts of research it is the preferred choice of risk-averse individuals.