Investing vs. Speculating: Why Knowing the Difference Is Key
As the stock market bull potentially nears the end of its run and we head into the last two months of 2018, many investors are making adjustments to their portfolios. Over the course of my travels and in conversations with other industry experts, I’m constantly reminded the importance of: 1) understanding the difference between investing and speculating, and 2) understanding risk tolerance.
These are two primary points for any investor seeking to make sound decisions with their money to understand.
1. Know the Difference in Investing vs. Speculating
All definitions vary slightly, but most are along the same lines. An investment is an asset or item acquired with the goal of generating income or appreciation in the future. Speculation is a financial transaction that has substantial risk of losing all value, but with the expectation of a significant gain.
Notice how the definition for investment doesn’t include the word “risk.” Of course, every investment carries some level of risk; however, the potential of losing the entire principal investment amount is largely what differentiates investing from speculating. Other factors to consider include time horizon, decision criteria and investor attitude.
Examples of well-known and popular investments include the stock market, bonds, U.S. Treasuries and mutual funds. Assets that fall into speculative territory include options, futures, foreign currencies, startup companies and cryptocurrencies.
Take cryptocurrencies, for example. These digital coins, such as bitcoin and ethereum, surged in popularity late last year and are known for having high volatility, or price swings. Many consider cryptos as speculative assets due to their relatively short existence in the financial world, absence of sound regulation and the many unknowns surrounding trading patterns.
What about the lottery? The Mega Millions made headlines last week for ballooning to the second highest jackpot ever, after failing to find a winner in the 25 drawings since July. Approximately 15.7 million people bought tickets for a one in 303 million chance of selecting the right six numbers, and just one lucky person in South Carolina won the $1.54 billion prize. Is buying a ticket speculating? Or is it perhaps gambling?
I believe it all comes back to the level of risk.