Differences Between Investing & Speculation

To have a good understanding of what investing is about, we first have to know what investing is NOT. When we talk about investing in the stock market, many would relate that to speculative actions, such as trading a stock for the short term or buying into a stock because it is “HOT” now.

Here are the key differences between what is true investing and what is speculation. It is important for you to know where is the line in order to position ourselves as successful investors in the future.

Invest With Logic

Investor: An investor will work through a possible investment with logic. He (She) would think through the reasons of what makes a stock a good investment. For example, he might invest in a company that has good growth potential in the future and was valued relatively cheaply by the market compared to his estimation.

Speculator: A speculator would not base his (her) decision on logical thinking. He might buy a stock just because it has fallen in price and he expects it to rebound in the future. There is no basis for why the stock might recover from its fall. Similarly, if he merely buys an oil and gas company because he feels that might strike an oil field in the future without any real evidence, it is a form of speculation. This is because there is no real logic reason on why the company is close to discovering an oil field and no analysis on how that oil field might be profitable for the company.

Invest With Risks In Mind

Investor: An investor would analyse an investment in term of risk and return. Apart of analysing what is the potential upside for an investment, he would also be mindful of what are the possible downside risk if he invests into the stock.

Speculator: A speculator might disregard the downside risk of an investment altogether. A speculator focused on “flipping a stock without much consideration on what will happen if something goes wrong”. For example, he might buy a stock trading at $0.10 per share and hope to sell it at $0.20 per share. However, there is no basis of why the stock should be trading at $0.20 per share and he does not take into consideration what happens if the stock fell to $0.00.

Invest For The Long Term

Investor: One key difference between an investor and a speculator is their time horizon. An investor would generally have a longer time horizon when he invests in a stock. He has the patience to allow the company to grow over many years and build up its business based on fundamentals. For example, an investor might be at 30 years of age and has the plan to invest for the next 40 years. If he buys a few small-cap companies based on logical analysis and keeps them for the next 40 years, he can be considered an investor. This is because he is buying the companies based on its fundamental merits and is able to have the patience to let these companies grow over the long term. Over the longer term, the success of the companies are due more to their ability rather than luck.

Speculator: In the same situation, if a speculator is around the age of 60 years and buys a few small-cap companies, hoping to sell them for a profit over the next year, that would be speculation. This is because he has not taken into account his risk; would he be able to take the loss if something goes wrong as he might not have enough time to recover back his losses. Secondly, the success of these companies over the next year would depend more on luck rather than the fundamentals of the companies. This would mean he is merely betting on an optimistic outcome without any way of predicting the short term future.