Investing and Speculating are not the same thing!

Investing and Speculating are not the same thing!

Earlier this week I met a potential new client who’d unexpectedly come into a large sum of money. But when it came to the matter of investing they could only be described as confused. Having spent some time explaining the basics of a good investment process and plan, we got to talking about the difference between investing and speculating.

In my experience, it’s not uncommon to incorrectly use the word ‘investing’ as a substitute for the act of speculation. The conversation I had with my potential client, together with discussions I’ve had socially about ‘investing’ in the recent Cryptocurrency and Bitcoin flavours of the month prompted me to set the record straight. So here it is.

Wake up! Investing and speculating are not the same thing!

Anyone under the pretence that they are investing when in fact they are naively speculating is at serious risk of learning a difficult (and potentially expensive) lesson. I’ve been there and my experience on this matter is a direct result of the mistakes I’ve made in my formative years. But more on that later.

Here lies the problem. Good financial practitioners know intuitively when they or their clients are investing or speculating. But trying to explain it definitively is tricky because it is perfectly possible to invest or speculate in the same asset.

So, let’s start with investing. There are many ways to invest, whether it’s through the funds we recommend to the clients of Bunker Riley, or when individuals place their capital into a business or commercial venture. Heck, even sustained reading and study could be deemed an investment if you spend the time acquiring the right knowledge to improve yourself. But let’s stick with the financial description of investing here. In my opinion, investing displays procedural characteristics that speculating does not.

Investing, for most people, is the deployment of capital (money) in patient expectation of a reasonable future return having made measured, educated, calculated and evidence-based research.

There is a clear intention to avoid the risk of a catastrophic loss and at the same time make a suitable return. A vast amount of empirical and academic research suggests that this can be achieved by not trying to forecast the future direction of markets, instead buying and holding a diversified portfolio of assets for the longer term, whilst keeping transaction and management costs as low as possible.

Ultimately, investing involves a clear, fully understood, researched plan, with evidence-based rules used to reduce the probability of an unrecoverable capital loss. These rules also attempt to minimise the negative impact that human emotions have on investment plans, such as fear and greed (selling low and buying high) amongst others.

Investing: Measured, longer-term goals, evidence-based, rules-based, managed risk of loss, unemotional

Speculating, on the other hand, is more akin to gambling. You can find the non-financial definition in a dictionary as:

Speculate – To form a theory or conjecture about a subject without firm evidence

Conjecture – An opinion or conclusion formed on the basis of incomplete information 

The key here is the lack of evidence and/or incomplete information. On this basis speculators often display the opposite characteristics of investors. They deploy capital expecting immediate or short-term profit with little patience, completing next to no research, deploying capital based on hunches, hearsay and no evidence. They’re willing to put a large proportion of their capital at risk of significant and sometimes total loss in order to derive an outsized return.

Notably, speculators try to forecast the direction of markets, trading frequently to pick winners and avoid losers, using concentrated positions to amplify returns, invariably at a high transactional and management cost. And unlike investing, speculating is emotionally supercharged with exhilaration and excitement clouding the decision making process and a ‘Fear of missing out’ when others around them are making quick money.

Speculating: Impulsive, short-term goals, lack of evidence, incomplete information, unmanaged risk of loss, emotional

So, when I read or hear people talking about how they are ‘investing’ in the next hot asset I try not to roll my eyes.

Wake up! You’re not investing. You’re speculating!

Hopefully, now you can see why it is not necessarily the asset which determines if someone is investing or speculating. It is the process which leads to the deployment of capital. The purchase of shares, funds, Bitcoin or anything else can be simultaneously described as an investment to one person and speculation to another.

But is speculating wrong? Well, I don’t recommend it to clients but so long as the potential for a total loss of capital has no impact on your overall personal financial security then perversely, speculating can serve as a positive experience. Hear me out. There will always be a small group of people who are just lucky and through no skill of their own walk away from speculative bets with a positive return. But for most people, like the gambler who goes back to the betting shop just one too many times, eventually your luck runs out.

And I’ve done it and am no different to anyone else. Early in my career, I speculated personally with small amounts on the Alternative Investment Market looking for that elusive 10 x return. After some small wins, but eventually horrible, irreversible losses I realised very quickly as most speculators eventually do, that there are no shortcuts to making money from the market. And that serves as my positive speculating experience, shaping the investment advice that I give to our clients today.

Bunker Riley Ltd of 118 Piccadilly, Mayfair, London W1J 7NW is authorised and regulated by the Financial Conduct Authority. Registered in England No. 3361930
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