Sometimes, it’s worth spending the time to go back to basics. And here at Face to Face, that means an article covering some basic terms in the finance world. It might not be the most exciting thing you’ve ever read, but it just might improve your investment strategy and keep you from making mistakes on the stock market!
In this article, we’re going to be going over the differences between investment and speculation. These are both similar activities – they involve buying assets or trading on the stock market. But the motivations for each are very different, and so are the time scales and attitudes employed.
So, should you be interested in speculating with your portfolio, or stick to an investment mindset? Read on to find out.
Speculating vs. investing
So, what is the difference between an investor and a speculator? Unfortunately, that’s not the set-up to a joke! The two are really just different approaches or attitudes towards buying stocks or other assets.
An investor is looking to purchase parts of businesses (in the form of individual shares, or simply as part of a wider fund), in the hope that the company will take that investment money and use it to generate a profit. When you invest in a business, usually you would expect to have your money within that asset for some time – and you’re looking to recoup your investment either through dividends over a period of years, or to sell your assets for a profit later on.
Typically, with investments we’re measuring our assets in terms of yearly growth – so we’re envisaging holding over a period of several years. Of course, investments don’t always work out, and sometimes investors will sell quickly if new information comes to light. But in general, the process is fairly slow, investors will do their research into companies and funds, choose the right opportunities for them, and then hold over a period of years.
By contrast, speculators are people who are looking to make quick money by “flipping” assets. This means looking for stocks or other assets (such as currency, cryptocurrency or even oil) which they expect to quickly go up in price and selling them quickly to take advantage of the price shift. Speculators don’t particularly care what it is that they buy – so long as they think it’ll go up in price and do so quickly.
A speculation boom?
One of the reasons we’re talking about this now is that there has been a massive boom in speculation and speculative assets recently. Fuelled by cryptocurrencies and so-called “rocket stocks” or “meme stocks”, like AMC Cinemas or Gamestop, a lot of the discourse in the stock market over the past year has been focused on these speculative assets.
There are lots of reasons why these assets have become more popular. Things like coronavirus giving casual investors more free time and money, the internet making it easier to organise, to a shift in stock market sentiment encouraging people to try and make quick, easy money using options trading (essentially betting on stocks, without purchasing the underlying stock itself). With all of these reasons, we’re seeing more and more amateur traders purchase speculative assets and engage in this speculative buying behaviour, whether they’re buying crypto, out of the money call options, trading Forex (foreign exchange), or even simply buying stocks en masse based on online tip-offs.
What are the risks?
Now, don’t get us wrong – there’s nothing necessarily wrong with speculating, so long as it’s with money you can afford (and even expect) to lose. Speculating is essentially gambling. You’re taking risky bets with your own money that prices will move the way you want them to, but as we’ve seen with high profile crypto and stock collapses recently, prices can certainly go down as well as up.
Unlike with an investment, where you expect to put your money away for years and can therefore withstand any short-term downturn in stocks or markets, if you’ve bought speculative assets you stand to lose a lot more if the price takes a temporary dip. And we often see that a lot of these assets will drop in lockstep with each other. When Bitcoin prices tumble, the entire cryptocurrency space can have millions in value wiped out in a matter of minutes, so it doesn’t matter which currency you’ve bought.
Does speculation create bubbles?
As we’ve just mentioned, we often see that the prices of these speculative assets are often linked together. When prices increase massively like this, we refer to it as a “bubble”. As more and more people pile into the stocks, the prices get pushed higher and higher, often multiples of what the company is really worth.
At that point, most speculators are simply relying on the “greater fool” theory – the idea that there’ll always be someone willing to pay more than they bought for the stock, so they can always make money selling it on. Eventually, this will run out – there’ll be nobody else willing to pay a higher price for the stock. The price will tumble, and the last people to buy it at the highest price will lose all their money on the way down.
These bubbles can be dangerous places to purchase assets. There can be money to be made if you get in early enough, but how do you know when the bubble will burst? Often, this happens in a matter of minutes, and suddenly all the value is gone. Even professional investors have difficulty timing their asset purchases.
So, speculation is a risky approach to purchasing assets. It’s certainly not a strategy we’d recommend for those looking to build a long-term, sustainable portfolio. With any investment opportunity, take the time to do your research and identify assets you’d be happy to hold over the long-term. That way, even if the share price does fall, you’re happy to ride out the dip because you believe in the business’ fundamentals.
Looking for more investment advice? Why not check out our sustainable portfolios, perfect for those looking to invest ethically.
This article is informational and for entertainment purposes only. It should not be considered as investment advice. Your capital is at risk when you invest.