Understand That Speculating Is Not Investing

I was a speculator initially

When I first learned about investing, financial markets, trading and portfolio management I came in with a wrong uninformed mindset. I started my personal brokerage account and ended up buying in shares in companies that I thought were going to rise in price in the short term and then try to sell at the peak price. I was not making investments because I liked the company’s fundamentals at a reasonable price point, nor was I reading any financial reports, industry research or doing other types of analysis. I was a speculator not an investor. I ended up falling for what the media portrays investing, which is the idea that you have to day trade and move in and out of positions on a short-term basis making capital gains. 

Seek out education on investing

My mindset changed when I started to educate myself on finance and investments as well as entering the financial services industry to start off my career. I began to understand what the difference between an investor was and a speculator. This is very important especially if you want consistent growth, capital preservation and making investments that are suitable to your risk tolerance and objectives.

Speculating is glorified in the media due to the excitement of making potential returns to beat the market or the wiz kid that turned $5000 into a million in 2 years. There is also an adrenaline rush it gives you just like you were gambling at a casino. Speculation does have its place in trading and portfolio management, but should only be used in certain scenarios and within specific limits of your overall portfolio. 

Describe the difference between Speculating and Investing    

Speculating

When you speculate you are typically aiming for capital gains on a short to medium term basis. People that move in and out of positions in this time frame do not hold the security long enough to receive dividends or even ride out volatility of the price on a long-term basis.

Speculators attempt to predict swings and trends that may deviate from the fundamentals and largely rely on technical analysis, market sentiment and events that may trigger market reactions.

Speculating is inherently riskier than investing especially for an inexperienced trader. In my opinion, speculating should only be done when you have surplus capital (capital beyond your liquid cash reserve and diversified portfolio). This amount of capital dedicated to speculative investments should only be 5% of your overall portfolio (10% if you have a stronger risk appetite) because if your speculation is wrong your portfolio is not blown up.

Commodities, cryptocurrencies and derivatives tend to be speculative in nature because they do not serve as assets that actively produce earnings.

 

Investing

As an investor you conduct a thorough fundamental analysis and valuation of the potential investment. You may also use technical analysis to check yourself, but it is not the primary method of analysis. In your investment selection you are focused on investments that have strong earnings potential with consistent cash flow at a good price. You may also look at the opportunities for potential growth and the level of risk the investment entails.

Overall your goal is to allocate capital in investments that will produce more cashflow and earnings than the initial amount of capital contribution. You may receive returns via dividends, coupon payments and various other methods for investments that are not securities. While capital gains are not your primary focus, they are still an added benefit and should not be ignored.

 

The Bottom Line

Are you an investor or a speculator? Educate yourself and be sure that you are an investor. If you have a strong risk appetite and have some excess capital that you are willing to lose then start a personal brokerage account with an aim to be speculative.

 

Best Regards,

Nigel