I know, it seems reckless. But, admit it, you’re curious.
You’ve seen wealthy fat cat investors on TV, and you know investing could make you some money.
It’d be great to take the children on a holiday, set up a university fund, or buy that ridiculously expensive bag.
But, what if you invest your money and you lose it all?
What if you’re taken for an idiot by all that jargon, the crazy charts, and those assertive, young traders?
The thought of it is enough to put your cash into a nice safe savings account. It may take a while to save up enough for that holiday but at least your money’s secure, right?
But, did you know a savings account often loses you money?
And that risky speculation, based on nothing more than your blind faith that prices will go up, isn’t investing.
Real investing is about making sound decisions.
It’s about managing your risk. And it’s about making you the passive income you want from your hard-earned cash.
Sounds good? It is.
But to do it properly, you need to understand why real investing is different from risky speculating.
Reasons why investing is different from risky speculating
What is an investment?
1. Real investing is about making an income from your invested amount.
This amount is called the principal. Investing is about keeping this money and making more, known in the jargon as a return.
Some people call this return ‘passive income’ because you’re not actively doing anything to make the money. I disagree with this for reasons that, hopefully, will become obvious as you read on.
Investing aims to keep your principal and to get an adequate return on it.
Sometimes, your invested capital will go up, but that’s not necessarily the aim of investing in itself. This is often the case with shares.
You buy a share in a company, and the price of the share will go up and down on the stock market. But, if the share pays a dividend, a small percentage of money that comes from a firm’s profits, you’re still making some money. This is true even if the price of the share goes down. The same is true of bonds.
Bonds are little packages of debt. You loan a company some money, and it makes a coupon payment back to you for the duration of the loan. It will then return the money at the end of the loan period.
Speculating is different. Speculation is throwing money into something without being able to determine what you think your purchase is worth. It’s a very high-risk strategy. Sometimes you win, sometimes you lose.
For example, buying snow globes, pictures, or wine is often considered investing. It’s not. It’s speculating.
The value of these things is based entirely on demand and supply in the market. They’re items with no intrinsic value of their own.
When people want them, the price goes up, when people don’t want them, the price drops. It’s sheer luck.
Real investing is different from risky speculation.
2. Saving is a form of investing.
It’s definitely not a form of speculation!
This is because you are actively trying not to lose your money by putting it into a bank account.
It’s also about growing your wealth which is a key goal. Moreover, it’s a major aim of investing too!
However, usually, when we talk about investing, we talk about buying stocks or bonds, rather than putting money into a savings account. And even if you’ve already got an investment portfolio, it’s often useful to have a savings account alongside.
However, savings do have a small amount of risk attached.
Many savings accounts have interest rates that are below the rate of inflation. This means you’re actually losing money from your account, in real terms. If the general price of things goes up by 2% and your account’s interest rate is 1%, your money won’t buy you as much as it used to.
Speculation, though, is completely different.
It has nothing to do with saving money.
It’s all about expecting a specific gain based on nothing more than a guess something might happen.
But, sadly, it’s rare you’ll get that gain over a period of time. Most people don’t.
Saving, in contrast, is relatively low risk, And investing is too.
3. Investing involves managing risk
Managing risk is about reducing what we don’t know and increasing what we do.
Only by removing, or limiting, unknown factors can we come up with a manageable plan, or a set of criteria, to increase our chances of success.
The ‘Father of Value Investing,’ Benjamin Graham, had 3 criteria for investing that do exactly this.
- Thoroughly analysing a company, and making an educated judgement on the soundness of its businesses, before ever buying a stock.
- Making sure you deliberately protect yourself against losses, especially serious ones.
- Not aspiring to crazy levels of wealth. Make one of your goals an ‘adequate’, or satisfactory, investment performance.
One of Ben Graham’s biggest disciples is legendary investor, Warren Buffett, one of the world’s richest men. I think this situation is a pretty good advertisement for the quality of the advice!
Indeed, at the heart of these criteria lies one simple, but time-consuming question:
If there was no market for these shares, would I be willing to have an investment in this company on these terms?Benjamin Graham, Forbes, 1st January 1972.
In other words, only own a stock if you’re happy with not knowing its forever-changing share price.
Investing is about managing risk, and Graham’s advice helps us do just this.
We should only make stock purchases we’re comfortable with, given our own individual circumstances.
On the other hand, speculating doesn’t consider this.
The speculator buys a stock and makes a bet the price will go up because someone else wants it more. But, there’s no analysis as to the actual value of the stock itself.
This makes it a high-risk ‘strategy’ if you don’t understand what you’re investing in because the prices of stocks and bonds go both up and down continually.
Indeed, it’s worth remembering that once you lose 95% of your money, you need to gain 1,900% to get back to where you started!
But, if you can manage your investing and control your fear, you’ll make money. Maybe not as much as Buffett, but you can do it because investing is different from risky speculating.
4. Investing uses a sound intellectual framework
The point above about managing risk shows that investing is a decision-making process based on a framework. For starters, you need to understand the environment of a firm, its strategy, and what its competitors are doing.
But, investing is more than this.
It’s a profession in itself, like law, medicine, or engineering. And like these professions, to be good at investing, it pays to understand its structure.
Firstly, don’t try to beat the market. It’s utter folly. The point of investing is to earn enough money to meet your own needs, not those of others. If you have a financial plan and are disciplined with your investments, you’re on the right track.
Secondly, you need a process to identify great stocks. Find companies selling at cheap prices, or those which may outgrow competitors over time. It’s even better if you can find a company with both these attributes. Forget the jibberish technical charts and share chat/gossip. Leave these to the speculators.
Lastly, control your emotions. It doesn’t pay to be overconfident.
When you’ve made good decisions and the market tanks, you can be confident and keep your cool. Wait for the recovery. If you flap, you’ll lose your money.
When the market seems unrealistically high, it probably is. If you buy shares now, you’ll buy them at high-end prices – just don’t!
And remember, what goes up, must come down….
Speculation, in contrast, doesn’t take any of this on board. It uses those candlestick charts, psychology, and peoples’ opinions to decide whether or not to buy a stock. Speculating is gambling that something will go up in price.
Some speculators sometimes appear to forget that data is not a substitute for knowledge and that real investing is different from risky speculation.
What is speculating?
5. Speculating is making money for your broker
This is so true.
Those happy young assertive types, laughing at the closing bell, that you see on the news? Of course, they’re laughing. They know they’ve made money that day!
You see, every trade costs money. So, the more you do it, the more you’ll end up paying your broker.
And speculation, like gambling, often involves continuous trading.
On the other hand, investing is choosing wisely and holding stocks for the long term.
Investing is making money for you.
6. Speculation is a get-rich-quick scheme
I think of speculating as the ‘Delboy and Rodney’ way of ‘investing’.
Remember them, of ‘Only Fools and Horses‘ fame?
Del and Rodney would wheel and deal through one dodgy scheme or another hoping to make millions. Well, speculators are the Dels and Rodneys of the stock market!
In contrast, investors look to the long-term. Investors don’t go in for get-rich-quick schemes.
Real investing is different from risky speculating because it’s not quick or easy. It’s hard work.
7. Speculating is seen as trying to beat the market
There’s so much nonsense flying around about ‘beating the market‘.
In stock market terms, this means getting a better return on your money than an entire index achieves, for example, the FTSE 100 or S&P 500.
But, is this over a week, a month or even a year? Which time period actually matters?
I can beat the market over a period of hours, perhaps. Maybe days. Maybe months.
The point is that beating the market over a short period is not proof your investing or trading strategy works.
It’s sheer dumb luck. That’s all.
But, it matters to a speculator because they’re often after a quick win from a stock ‘bet’.
However, to reach your long-term financial goals, you need to be right about your strategy for a long time. This could be decades. It means that over certain time periods, sometimes you’ll beat the market, other times you won’t. Don’t fret.
The important thing is the gradual trend that occurs when you pick a stellar firm in which to invest your money.
And, years of get-rich-quick scheming is unlikely to achieve this. In fact, it usually doesn’t. Even for professionals.
So, trying to beat the market is just not worth your while. Leave it to the risky speculators because investing is different from risky speculating.
8. Speculating is reactive. Investing is proactive.
It probably sounds funny to say that speculating is reactive when there’s so much excitement about something that may or may not be about to happen.
But, it’s true.
Speculators use charts and other technical means to provide data for a gamble that something will occur. They use past market data to speculate about what’s going to happen to a share price.
They look for patterns like trendlines, price channels, and shapes in the data, to give them a steer as to what’s about to happen with a stock’s price. And to do this, they have to act in retrospect, looking at events that have already happened.
This often makes it easy to buy when prices have already gone up and sell when prices have already gone down. Completely the wrong way around!
On the other hand, investors recognise that these data points represent companies. They’re not only points on a graph. This means they are reflections of what the market thinks of a company’s strategy, environment, resources and other factors, at any point in time.
Usually, the market is reliable over time, but sometimes it does get it wrong. And this is when the real bargains are found. But, an investor uses what they know about a firm and its environment to make an educated judgement about what the future may hold.
Investing is forward-looking. Not retrospective. And it’s different from risky speculating.
9. Speculating is ignoring logic and giving in to your own psychology.
The biggest form of speculation is your own psychology.
Does this surprise you?
How many times have you analysed something and then dumped all your hard work for nothing more than a ‘gut feeling’?
I know I have.
Speculators allow this gut feeling to drive decision-making. Investors stick to their guns because they believe in their own work.
When you think about it, risk is incurred every time a stock is bought and sold. A buyer purchases the risk that a stock will go up in price. In contrast, a seller holds on to the risk it will go down!
It’s important to have the discipline not to sell a stock because its price is falling.
Unless, of course, it’s due to a big negative change in its underlying business.
And this is why your own psychology may be your biggest risk. If it’s a good business, it’ll go back up again at some point.
Investors use their heads. Speculators are guided by feelings.
Other reasons why investing is different from risky speculating
10. There’s no such thing as a reckless investor.
There are only speculators and investors.
Despite the over-used term ‘investor’, not everyone who puts money into the stock market is an investor.
If you don’t do your homework on your share purchases, you’re being reckless, and you’re not investing.
Therefore, by definition, a reckless investor is not an investor at all, but a speculator.
Real investing is different from risky speculating.
11. Speculation may produce big returns.
Even more so than investing.
But, with the reward comes a risk of a similar size. If something has a large return, it’s probably largely risky.
And risk, in this case, means losing your money.
Investors put as much effort into preventing this from happening as they do in trying to get returns.
Consequently, an investor will often ignore those so-called ‘hot stocks’ that are all the rage in the news because of their big potential returns.
Buying ‘hot stocks’ is nothing more than gambling. Unless you’ve done your homework first.
In contrast, a speculator loves hot tips and happily buys a firm stock off the back of them. Just in case.
But, what if those tips are wrong as they so often are?
Speculating produces big losses too.
And usually more often than those big returns.
Speculating and investing aren’t mutually exclusive
Some speculation is necessary to be able to invest at all!
This is especially true in a so-called ‘bull market’ when shares are increasing in price.
Indeed, the higher the price of the stock, the more risk you’re taking with it and the more speculative it becomes.
The higher the price you pay, the lower the gains you’ll receive in percentage terms. But, also, the further the stock can fall.
There are risks of profit and loss with every share purchase, so some speculation is unavoidable.
In addition, new companies need people to take a chance on them by providing them with capital – with money. Only by investors doing so, can they test themselves. If no one had taken a chance on Tesla or Amazon, the companies wouldn’t be where they are today.
But, an investor will understand the risk and doesn’t mistake it for ‘investment’. (S)he will also never risk more than they are prepared to lose. A speculator is indifferent to the risk.
Investment is different from speculation but not exclusively so
Now you know investing isn’t reckless after all!
It’s very different from risky speculating but is also necessary in small amounts.
The more questions you ask and the more curious you are about investing, the more successful investor you’ll be.
Whether it’s Piña Coladas on the beach, a teenager away at university or that beautiful designer bag you’ve coveted, the rewards are there. Perhaps it’s something smaller like food shopping, a new school uniform, or a car service that you don’t need to spend hours slaving away for. You can afford these things by making passive income investing.
However, you’ll know by now that there’s no such thing as ‘passive’ when it comes to investing. So, use the word as a noun and not an adjective! Call your investing returns ‘passive income’ but underneath, remember what you did to earn it.
That work is what separates real investing from risky speculation.
It’s knowing that investing is as much about not losing your money as it is about making gains.
You can ignore the jargon and the crazy charts, Focus on the businesses underneath the data.
Be amused you’re not giving those assertive young traders any more cash than the few quid you need to buy your shares. They won’t be laughing at you at the closing bell, that’s for sure!
You know to make sound decisions and manage your risk.
Go do it and watch your passive income climb. You deserve it!
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