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Sunday, June 23, 2019

Difference Between Investment and Speculation

There are many people who purchase stocks thinking they are making an investment and not knowing they are actually speculating. They buy certain stocks with just certain assumption that the stock will go up in price without doing a thorough analysis. And yes, some people actually do make capital gain from speculating and sometimes they made a lot of money. That is what we call speculating. The person who made tons of money from speculating on certain securities might just be lucky. However people need to know the difference because Investing and Speculating. Those two are totally different terms. Benjamin Graham who is Warren Buffett’s mentor believed in separating investing from speculation. I strongly agree with that ideology because not knowing the difference can cost you dearly. In this article, I want to talk about the difference between Investing and Speculating, and why I personally dislike speculating and prefer Investing instead.

So what is Speculation?
The term ‘Speculation’ can be defined as an activity that commits funds in financial or physical assets with to generate profit return in a short term period. With speculation, there is a potential of high return but as well as a high loss. A speculator is usually speculating on financial or physical assets based on what is trending. Bitcoin is an example of a financial instrument that people speculate on. It’s true that there are many people who made lots of money purchasing Bitcoin when it was still cheap; however Bitcoin is just a physical instrument that has no fundamental value behind it. And the funny part, people actually bid higher price for it and expecting a huge capital return from a financial instrument that has no intrinsic value behind it. People buy Bitcoin hoping that in a short period of time the price would increase in price and sell it at profit. This is just one example. Another example, people can speculate on many other things such as stocks, currencies, and properties; however they tend to hold for a short term period rather than a longer horizon. Speculators tend to earn their profit upon the fluctuation and changes in the market price. They are all concerned with the changes in price. In some cases, they only care about the price changes alone. When they see a financial instrument such as stock going up in price, they also want to hope in the ride without knowing what the financial fundamental behind it. This can be dangerous strategies because you can end up overpaying for a security. It’s true that the price of the security can go up even further; however seeking on price changes or fluctuation is not a good investment strategy.

What is an Investment?
An Investment involves allocating money towards the purchase of an asset which is not to be consumed in near term but to seek value towards a long term horizon and focus on stable return. Investment is one of the most crucial aspects of financial planning to ensure that your money is not lying unproductive. Because of inflation, the money today will not have the same value decade down the line. Unlike a speculator, real investors are more interested in safety of the investment rather than what the price will be in short term period. As Benjamin Graham mentions in his book “An investment operation is one which, on thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” An example of an investor that invest is a person who buy certain stocks because they know the fundamental of the business and does a thorough analysis how the business is going to be in the future. In addition, they also understand the business model and like to buy these companies at fair price or sometime oversold territory.

Why I personally dislike Speculating and Prefer Investing Instead?
I personally do not speculate because I know the risk behind it, and yes I know sometimes I can be lucky and earn a quick buck here and there, but it’s almost impossible to time the market. Once I personally tried to time the market myself by doing speculative trading (chart analysis etc.) and my portfolio went sour because of that. And not only because of the experience that I had gone through, I also read up on many great value investors such as Benjamin Graham, Warren E. Buffett, Peter lynch etc. and they did say the same thing as well.

There are many who claim that they found the secret to become a successful trader. Traders often use technical chart to time the market. This is a tool that looks at the past performance as an indicator for how the stock will perform in the future. Yes, this might be true, however if you look at the percentage of traders who lost money is huge.
90 to 95% of traders lose money! Most importantly if you do see a successful trader out there who shows their lavish life style and asking you to enroll to their courses, these people actually make their money through the courses they sell in order to have that successful life. In another word, they are not genuinely become wealthy through their trading life style but because of the courses they ask you to pay for. This is the reason why I do not speculate or day-trade on stocks after the experience I went through and gaining the knowledge from many value investing books. This then make me prefer to do investing instead of speculating. As a Dividend Growth and Value Investor, this technique is considered as Investing. Instead of timing the market, like many traders or speculator do, I use the price fluctuation (Mr. Market) to my advantage. Since the stock market can go up and down at any time, I tend to use this fluctuation to purchase a stock when the price is at bargain or at the intrinsic value. And I’m not talking about seeing the price of stock chart going down as a bargain, but I uses financial metrics and discount cash flow analysis to evaluate the company whether it is at the price I want to buy it at. I also do use the same strategy to see if a current position is getting overvalued. What I normally do is to sell some shares from a company that is overpriced and use the money to purchase another great company that might be priced more fairly. Applying this quantitative strategy, I am able to hold shares that have a better fundamental and also yield a higher dividend. With the higher dividend pay I get, I am then able to purchase more great companies that have good fundamental and business background. This is how I am able to compound my portfolio in the long run.   

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