Investment vs Speculation: Suppose there are two people – Rohan and Rahul, who wants to buy a milk distribution business and both have several options available in their locality. However, both Rohan and Rahul, follow a different approach.
Rohan goes and visits the owner of the business. He discusses the business- how it works, how are the sells, how much profit the business generates in a year, how many vendors they have etc.
Next, Rohan studies the financial statements of the company. He analyses the assets and liabilities of the companies balance sheet. Then, he studies the year wise revenue and profit generated by the business through the Income statement. He also looks at the net cash flow of the business from the cash flow statement.
Overall, Rohan analyses the business for weeks and comes to a decision of buying that business.
On the other hand, Rahul heard from somewhere that the prices of milk are going to rise in the future. In order to not miss the opportunity, he buys some milk distribution business with expectations that the milk prices will rise soon and he will make good profits from his business.
What do you think? Who will get better and consistent returns from his investments? Rohan or Rahul?
Yes, you are right. !! Rohan!
Why? That’s what we are going to discuss in this post.
Investment vs speculation
The difference between investment vs speculation is amazingly described by Benjamin Graham, the father of value investing, in his book “THE INTELLIGENT INVESTOR”.
Here is a quote from the book about investment vs speculation:
“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” -Benjamin Graham
According to Benjamin Graham, there are three equally important elements that should mutually exist in an investment:
- You must thoroughly analyze a company, and soundness of its underlying business before you buy its stock.
- You must deliberately protect yourself against serious losses;
- And you must expect adequate returns, not extraordinary performance.
On the other hand, speculations are those which doesn’t go through proper analysis, do not consider the safety of principle and expects inadequate returns.
Few key differences between investment vs speculation
- An investor properly analyses the worth of the stock based on the value of the business before investing. On the other hand, a speculator gambles that a stock will go up in price based on just the market price. If the market price of that stock is not available, the speculator won’t make any decisions.
- For the investment, returns are stable and recurring. On the other hand, the returns of the speculators are uncertain and erratic.
- Investors have a modest return expectation from their investment while speculators have an unrealistic high return expectation.
- Investors buy with an intent of receiving returns along-with safety of their investments. Speculators buy assets with an intent of making profits.
Why do people speculate in the stock market?
Speculating is nothing new to the financial world. For generations, people have been speculating in casinos, horse-race or gambling among each other in expectations to make quick high returns.
People speculate in the stock market because it is exciting and sometimes can be rewarding.
Nevertheless, most of the wealth created by speculations are temporary and moreover, non-repetitive. In most cases, this happens only when people get lucky. But, are you?
Why speculating the in the stock market is dangerous?
Just like casinos or horse racing bets, the share market is also not made to profit the common people.
If you take the case of any casino, it is made in such a way that the house always wins and snitches the money from the majority of the people (if you do not count a few of the lucky ones).
In a similar manner, the stock market is also made in such a fashion that if you are speculating in the market, the winners are always the brokers, stock exchange or the 5% of the intelligent investors.
The most common myth in speculation: If it worked, it means that you’re ‘right’
Most people think that the best way to test an investment technique is simply to find out whether it “worked” or not.
If it worked, then people conclude that their investment technique was ‘right’, no matter how dumb or dangerous that investing tactic was.
Nevertheless, for building wealth over the long term, you need a reliable technique. Just because it ‘worked’ this time, doesn’t guarantee its future performance.
Being temporary ‘right’ won’t help you much over the long term if your technique is not sustainable.
3 worst mistakes by the SPECULATORS
- Thinking that you’re investing when you’re actually speculating: There are a number of people who don’t know how to pick a fundamentally strong company or how to invest systematically in the market. That’s why, many a time, they are convinced that they are investing, whereas in actual, they are speculating.
- Speculating become more dangerous when people get seriously involved in it. Going to casinos one or two times a year, won’t hurt you much. However, if you start taking it seriously and start visiting regularly, then the rest is all up to your fate. Similarly, speculating in the stock market by getting seriously involved is quite dangerous to you, both financially and emotionally.
- No strict limit to the amount of speculations: Even the best gamblers take a limited amount of money to the casino floor and keep the rest of their money safe in their locker.
Not everyone can be a conservative investor. However, if you are planning to take speculative risks is expectations of amazingly high returns, be it a small part of your total portfolio. Fix a maximum permissible amount, say 10%, to put for your speculations.
Both investing and speculation involve risk and reward.
However, the investors are interested in making returns with the safety of their investments and hence reaches their decision only after a proper analysis. On the other hand, speculators care more about profits, ignoring analysis, safety, and adequate return expectations.
If you want to get consistent returns from the market then you should start investing instead of speculating. Speculating in the stock market is the worst way of accumulating wealth.