The Difference Between Investing and Speculating (and Why It Matters)
It could be said that the difference between investing and speculating is simply a matter of risk tolerance, while speculation is closer to gambling. The truth is, there is no clear line between the two, as any investment comes with risk. However, there are differences to be aware of regardless of your financial goals.
Investing is usually a long-term game
Definitions vary, but investing is most often seen as an attempt to profit from transactions, stocks, or assets. A safety first approach is often used, as the most conservative investors will sacrifice potentially higher returns in exchange for less risk of losing their principles . Safe investments can include bonds, real estate purchases, loans to low-risk borrowers, or blue-chip stocks .
To ensure the maximum margin of safety, investors evaluate various assets, industries and market trends and try to select the investment that gives them the best chance of making a steady return. The most conservative investor will avoid short-term market volatility by investing in assets or stocks over the long term, often over many decades, in so-called “passive” investing. This strategy has worked well (think Warren Buffett), especially with investments in the stock market, since its historical return on average averaged about 11% per year . The “middle” part is important because the longer money is invested, the more it will worsen , making it less susceptible to short-term double-digit market downturns.
Speculation usually focuses on short-term gains.
The old adage “big risk brings big reward” applies to speculation, which is the act of putting money in investments that have a higher chance of failure and sometimes pay off with higher rewards. Speculators (including impulse traders ) tend to trade more frequently and place bets in higher risk markets such as commodities, cryptocurrencies, or small or distressed stocks.
However, just because speculation carries a higher risk doesn’t mean it’s all about gambling. The same level of scrutiny and research that applies when looking for long-term investment opportunities can be applied to short-term cycles and market behavior (for example, you could argue that Gamestop’s short-term squeeze was a rational investment ). However, when you have people making these trades based on zero knowledge of what they are investing in (like cryptocurrency , often), well then yes – it’s mostly gambling.
Risk is a spectrum that includes both investment and speculation.
To understand whether you are investing or speculating, it is not what you buy that matters, but why you buy – and it depends on people depending on their financial goals. For example, a low-income worker close to retirement probably won’t want to cash out his 401 (k) egg in order to chase a short-term rally in AMC stock. In contrast, someone with a lot of wealth might want to reduce their exposure to only stocks or bonds, so they might be happy to invest a small portion of that wealth in high-risk intangibles like cryptocurrencies.
While knowing the difference between low and high risk investments is important, it is more important to know what your own risk tolerance is (more on that here ). And since a lot depends on your age, financial status, and retirement goals, consider consulting a financial advisor who can help you find the trade-offs associated with investing and speculation.