The Difference Between Speculating and Investing

I may earn money or products from the companies mentioned in this post.

 

I feel like there will always be a debate about what's considered speculating and what is really considered investing.  Most of the time, in my opinion, people confuse speculating for investing rather than the opposite.  It helps them justify buying a stock they believe will go up in a short period of time.

But when you really look at it, it's pretty obvious at times when you're guessing a company's stock is going to go up compared to the actual practice of investing.  I know people who speculate all the time.  It's ridiculous to me that someone could willingly give themselves that kind of anxiety and most likely, terrible performance.  Even if you threw only $300 in say something like stock in PayPal and lost only $20, you still lost over 6% of your investment in less than a month.  Not that I know someone who had exactly that happen to them or anything…

 

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But first, let's start with the basics:

 

What is meant by speculating and what is meant by investing?

Speculating to me is when someone puts their money in a stock only hoping it will go up, based on short-term expectations, usually because of some big news they read online or in the papers or heard a “hot tip”.

Take Facebook for example.  Their stock tanked 13% in the last month because of their whole privacy issues with Cambridge Analytica. If you didn't even care about how the business was run, didn't research their financials, didn't care about the direction of the company, didn't read the annual report, etc. and still put money in the stock, you're speculating (guessing) the stock will go up in the short-term to make a quick buck. And this is only based on a hunch you have that the stock is bound to go back up soon because of the drastic drop.

Literally, the second definition that comes up in Google when I type in “speculate” is this: “invest in stocks, property or other ventures in the hope of gain, but with the risk of loss.”

The key word here is hope.

When I buy a lottery ticket, I hope I win.  When I fill out my March Madness bracket, I hope I pick all the winners correctly.

Zero research goes into my lottery ticket and honestly, the more I research for March Madness, the worse I do anyways so I just stick to knowing nothing now.

If you bought Facebook stock after it briefly tanked, you hoped it went up soon.  To speculate is to trade.  Trading is not investing, trading is trading.  It is buying and selling at a rapid-fire rate based on hearsay.

Not only is it a waste of time, it's stupid for you because you'll be charged more in fees and you'll be taxed more for short-term capital gains.  It's a lose-lose proposition for you.  In addition to the negative side effects of sleepless nights and anxiety, you lose all your money.  Why even do that?  Just give yourself a 4o year timeframe and you'll be fine as long as you're patient.

Investing on the other hand in my opinion, is when you do your research (which by the way could take months), understand the business the company is in, the overall industry, the outlook for the industry as a whole, how the company operates, read the annual reports and patiently wait for the right time to pull the trigger.  There are several other things to consider, but you get the idea.  It could take you months to do your research, and that's okay, there's really no rush.

I understand there's a constant anxiety of trying to anticipate when the best time to invest is when you're following a company's stock day by day, but I've come to realize it's ridiculous.  In the long run, it makes no difference.  Take your time and make sure you're making the right decision.

I used to feel that way, and it drove me nuts.  But now it makes no difference to me.  I've made my fair share of mistakes investing in terrible stocks and invested at the peak, but I learned from all the books I've read and am a hell of a lot better investor because of it.

Read the books. 

You also have to have a long-term approach as an investor.  Not a few months or even a couple of years.  You aren't looking to seek rewards from the stock you invest in within the next 10 years, so you force yourself to make sure you're making the right decision by doing your research.

And as an investor rather than a speculator, you realize there's no point in buying stock of a terrible company just because you think it'll go up soon.

Think of it in terms of going to the casino.  Speculating is to roulette what investing is to counting cards.

Playing roulette takes no skill.  It has everything to do with guessing and playing based on a hunch the ball will land on either a color or a number based on some news beforehand, that really has no correlation at all.

When you're counting cards, if anyone's seen the movie 21, a lot of preparation goes into the process if you're trying to go unnoticed and make a profit from it.  These guys practiced over and over and over again learning their craft.  Only when they knew they were as prepared as they were ever going to be, did they finally go to Las Vegas to not gamble, but count cards and bet heavily when the numbers were in their favor.

It's the same idea with investing.  Only invest once you're super prepared.  Of course, this really pertains to those who want to invest in individual companies.  If you want to invest in an S&P 500 index fund, then, by all means, follow the method of dollar cost averaging and enjoy the rest of your life, it's all good.  That works for probably 99% of the people in the US since they probably aren't as into investing as you or me am.

 

Speculation has more to do with charts, technical analysis and following short-term current events to take advantage of people's impulse reactions in the markets.  Just look at the show Billions.  The way Axe Capital makes money is by literally making highly educated guesses about current events.  Yea it's just a TV show, but it does provide an element of truth in that hedge funds essentially guess what's going to happen based on hunches.

Bobby Axelrod is a trader, which is another word for a guesser, albeit a very good one.  Which is why 80% of hedge funds fail in the first year alone.   Guessing isn't a very good strategy.  And it's also why there is such high attention received by the SEC on hedge funds because there's always a possibility a fund used inside information in a very profitable year because the chances of scoring high rates of performances in such a short span of time are extremely difficult.  It's possible, but it's not likely.

You want to be like an investor; where the primary interest is in acquiring and holding a great company's stock for the long-term.  Yes, you want to wait for the stock to drop to a favorable price, but you're not banking on the price to fluctuate quickly so you can take your winnings after a couple of months or even a year from now.

You don't want to be a speculator where your sole interest is in making a quick buck off a stock's wild fluctuation regardless of the type of company it is.  It's reckless and you'll screw yourself over in trading fees.

Speculators look for quick profits whereas investors look for passive income over the long-term.

Did you buy PayPal stock? Why?  Because it dropped 6% in the last week?  In my opinion, they could easily be overrun by another startup payment company.  If they didn't buy Braintree who bought Venmo, who knows what could have happened.  I prefer to use Venmo way more than PayPal.  And as far as I know, it's only in the payment services industry.  They need to be more diversified for my taste.  They come off as a one trick pony.

Apple or even Amazon (even though they don't have a dividend) on the other hand, are in a class all on their own.  Everywhere you look you see a MacBook or an iPhone whether in real life or on TV shows or movies.

Apple has become a luxury brand you want to associate yourself with.  They've built a ridiculously loyal customer base who upgrade their products time and again, even when it may not be entirely necessary to.  They've created themselves a wide space or as Warren Buffet likes to call it a “moat” while focusing on innovation and their research and development teams.

Amazon is slowly taking over pretty much everything.  Today in the city every single cart with boxes on it to be mailed had a smile with an arrow on it, it was insane.  Last week a co-worker and I joked the entire mail cart that rolled past our desks was entirely Amazon Prime and that eventually, it'll be rolling itself around the building.

This is a great example of two companies to invest in, in my opinion, if someone was patient and waited for the stocks to come down from their highs.  If they did their research and understood what Amazon was doing and didn't merely speculate the stock was going to go up only in the next week, I think this could be a safe investment because of the wide moat they have built themselves.

They are the leader in delivering goods and are branching out into several industries.   Like today, for example, I just found out there was something called Amazon Home Services.  Literally, it's a part of Amazon where you can buy and schedule professional services like furniture assembly, house cleaning, even interior design!

It's companies like those that make it difficult for others to play catch up with that you invest in.  Of course, there are other factors I don't feel like getting into right now for the purposes of this post, but you get the idea.

 

Common characteristics of a speculator

• Looking to make a quick buck from a faster turnover of buying and selling stocks
• Holding stocks for short-term gains
• Doesn't do research on the company or its competitor, just buys on a hunch
• Is impatient
• Takes on a lot of risk

 

Common characteristics of an investor

• Reads and researches the company they are interested in buy stock of
• Researches its competitors
• Puts money into the stock of a company for the longer term, preferably at least 10 years without selling
• Doesn't get easily influenced by the media and has a cool temperament when unfavorable news arises
• Realizes a stock could go down just as easily as it could go up in the short-term
• Doesn't base decisions off hunches

 

If you want to give yourself the best chance of long-term success, you will need to realize the difference between speculating and investing and think of yourself as a long-term investor.  The longer your time horizon is, the better your performance will be because you won't be subject to the short-term volatility that traders and speculators are, which ruins their fortunes.

Remember, to speculate is to guess.  You want to be able to sleep at night.  Usually, that means index funds are the best investment for you.  But if you want to become an investor in individual companies, take your time, do your research and take action if and only if the opportunity comes.  Don't force it!