Investing vs Speculating

In this article, we will see what is investing and how it differs from speculating. Investors and traders take on calculated risk as they attempt to profit from transactions they make in the markets. The level of risk undertaken in the transactions is the main difference between investing and speculating.

Learning Tip

The main difference between speculating and investing is the amount of risk involved. Investors try to take on an average or below-average amount of risk. While speculators are seeking to make abnormally high returns from bets that can go one way or the other.

Understanding

What is Investing?

Investing means the buying and selling of securities such as stocks, bonds, exchange traded funds (ETFs), mutual funds etc. in long duration.

Investors hope to generate income or profit through a satisfactory return on their capital by taking on an average or below-average amount of risk. Income can be in the form of the underlying asset appreciating in value, in periodic dividends or interest payments, or in the full return of their spent capital.

Most often, investing is the act of buying and holding an asset for the long-term. To classify as a long-term holding, the investor must own the asset for at least one year. For duration less than 1 year it is called short-term investing.

For example, consider a large-cap stable company as an example of investing. This company may pay a consistent dividend that increases annually, and it may have a low business risk. An investor may choose to invest in this company over the long-term to make a satisfactory return on their capital while taking on relatively low risk.

So, this is enough to understand what really investing is. Now let’s look into speculation.

Understanding

Speculation

Speculation is the act of putting money into financial endeavors with a high probability of failure. Speculating seeks abnormally high returns from bets that can go one way or the other.

These traders buy securities with the understanding that they will be held for only a short period before selling. They may frequently move into and out of a position.

For example, consider a volatile new AI based tech company with an equal chance over the near-term of skyrocketing from a new AI revolution. Speculators may believe the AI company will become very large tech company in very short time and may buy its stock on a hunch. This hunch and the subsequent activity by investors are called speculation.

Comparison

Which One is Better?

Both investors and speculators put their money into a variety of different investment vehicles including stocks and fixed-income options. Stocks or equities represent a certain percentage of ownership in a company. These are purchased on exchanges or through a private sale. Companies are ranked by market capitalization or the total market value of their outstanding shares.

Investors may want to consider the holding period for their investments and their tax implications. The holding period determines how much tax is owed on the investment. This period is calculated from the day after the investment is purchased until the day it is sold or disposed of.

The Internal Revenue Service (IRS) considers holdings of one-year or more to be long-term. Anything below this is considered a short-term investment. Long-term gains are generally taxed more favorably than short-term ones.

The primary difference between investing and speculating is the amount of risk undertaken. High-risk speculation is typically akin to gambling, whereas lower-risk investing uses a basis of fundamentals and analysis.