Investment vs Speculation

Investment is when a security or an asset is purchased to hold it for a long-term period with a view that it will gradually increase in value over that period. Speculation can be considered a more risk-based transaction where the sole purpose is to profit from that transaction which is generally a short-term and often a single transaction.

Both these terminologies are generally used synonymously due to specific common characteristics, but there is a demarcation line to distinguish them.

In simple terms, investment involves purchasing an asset or security, hoping it will generate certain returns in the future. On the other hand, speculation involves an element of risk in a financial transaction and how sufficient profits can be earned from the same.

Investment is spread over a long time horizon, and the focus is on getting security and stable returns, whereas speculated activities are for activities for less than one year. In speculation, the objective is to make quick returns and may compromise on the objective of security.

Investment involves the allocation of money towards purchasing an asset, which is not to be consumed in the present but hoping it will generate stable income or is expected to appreciate in the future. The term is used very widely since it impacts every individual in life who desires to establish their financial future.

Investment can be used for defining any mechanism that can generate returns in the future. Financially, it will involve purchasing stocks/bonds, real estate, gold, or mutual funds are some common examples. E.g., one will purchase a share of Company 'A' for $4 in the current market with the hope that after, say, five years, its value will be $8 or more so that if an investor decides to sell, they would have made some gain than what they had purchased for.

The production of goods used as inputs for further producing other goods is also referred to as an Investment. The scope is not necessarily limited to the world of finance and can be extended to personal lives. For instance, learning an additional language may prove to be a fruitful investment if one gets an opportunity that requires knowing an additional language.

Economic growth can also be encouraged with the help of sound and calculated investments involving business decisions. When a firm creates or purchases utterly new equipment for production to improve the total output within the facility, this further causes the country's GDP to rise. 2 forms of investment exist, i.e., Traditional Investment and Alternative Investment. Some of the popular instances are:

Traditional Investment

• Stocks
• Bonds
• Fixed Deposits
• Provident Funds
• Gold and Jewellery

Alternative Investment

• Real Estate
• Private Equity Investments
• Antique Collectibles
• Paintings
• Hedge Fund Investments
• Structured Products

Investment is one of the most critical aspects of financial planning to ensure that the money earned is not unproductive. Today's money will not have the same value five years apart from the intrinsic value. Hence, saving money alone will not be sufficient for achieving future financial goals. Some of the most important reasons for an investment of money are:

• Investing in various financial avenues ensures money growth instead of remaining in the bank account with very modest returns.
• The yield returns help take care of emergencies such as Medical expenses etc.
• For personal investment, the entire family's future can be secured, such as the education and marriage expenses of children.
• Tax minimization is an additional advantage for governments worldwide to offer benefits to individuals and companies for making investments, mainly if they are associated with the Government of Government-backed institutions.
• Inflation can be successfully dealt with. Inflation will keep rising, and savings returns may not necessarily be enough. The value associated with the quantum of money depreciates with rising inflation. The impact of inflation in reducing the value of assets can be controlled by investing and generating returns on the corpus.
• It is an attractive way of earning income from accumulated wealth. E.g., rent earned from a real estate investment or stocks that have been purchased.

Speculation does not have a precise definition but involves purchasing an asset to profit from subsequent price changes and possible sales. The speculators indulge in marketable assets that do not have a long life.

The speculation involves a relatively higher level of risk and more uncertainty of returns though it can be on the same lines as an investor. These speculators are generally trained and take action when the game of probabilities is high in their favor. They are very proud of their opinion and consider placing a high premium. Decisions are considered when the atmosphere is of Panic, Confusion, or high levels of optimism but still go against the flow.

The probability of the opposite situation is difficult to occur, but the speculators can earn a hefty amount from that if it does. E.g., if the stock market is going through a bullish phase, and the scenario is optimistic, the chances of downfall are relatively less. Still, speculators can predict a bearish phase to arrive soon and place their bets accordingly. If the bearish phase does occur, speculators earn a huge margin since they made a prediction when bets were against their opinion.

Many may consider speculators as dangerous gamblers though they provide the much-required liquidity in the market, which is essential for efficiency. In certain sectors such as commodities, speculators provide substantial liquidity. The only participants would be the Food companies and the farmers, who may have limited ability to invest and assume the risk.

The bid-ask spread would be more extensive with lesser participants, and it would be harder to find a counterpart in case of trade closure. The resulting illiquidity will substantially increase the risk in the market and offer an opportunity to earn more, where the speculators cash in.

The selling of homes that followed defines a situation of a speculative market. The interest rates were low, and speculators were betting on home prices continuing to rise as more individuals would purchase homes (with the help of leverage) to sell them when prices rise further at hefty profits. Speculation can also spike the short-term volatility and risk, thereby inflating prices and leading to asset bubbles similar to the USA's 2005-06 real estate market.

1. An investment involves an asset with the hope of securing returns over the principal amount in the future. On the other hand, speculation involves conducting a risky financial transaction to make large-scale gains from a single transaction.
2. Investments are generally held for an extended period, usually more than a year. Instances like real estate and life insurance are held for 25-30 years. Speculation is held for a brief period, usually less than a year, and can even be on a forthcoming event.
3. The amount of risk assumed is relatively moderate as compared to speculation. Speculation will focus on getting high returns in a relatively shorter amount of time, and thus, the quantum of risk is very high. Since investment is mainly made by the middle class working for the community, they would be putting the spare money off their hard work, which they expect to earn a stable return. They are ready to part with their savings if it offers a definite return.
4. An investor will be using their funds for investing, whereas speculators will use borrowed funds and lure the borrowers with attractive returns.
5. The above point also reflects the attitude of the investors and speculators. Investors will generally follow a cautious and conservative approach while considering the investment and the risk appetite they can absorb. Speculators believe in an aggressive approach highlighting attack but careless attitude. As the returns are far too attractive, and the window of opportunity is very small, this behavior will easily get reflected.
6. Investors expect to profit from the change in the value of an asset, whereas speculators focus on extracting profits from price changes due to demand and supply forces.
7. While making decisions, investors will conduct extensive research and focus on the fundamental factors of the company, such as the financial position, ratio analytics, etc. In contrast, speculative decisions are based on technical charts, market dynamics, and personal opinions/tips received.
8. The avenues for considering investment will focus on the Blue chip companies of the stock market, savings bank accounts, provident funds, etc. Still, speculators will focus on the commodity market, options trading, betting, etc.
9. Investment does not give rise to practices such as insider trading or possible leakage of information, which can be observed in speculative activities since their returns are lucrative.
10. The level of patience and sacrifice is relatively large in the case of investment but not in the case of speculation. However, the probability of losses does multiply in speculative activities.
11. Investment activities are recorded separately in a firm's balance sheet of a firm, but speculation is not recorded separately. Depending on the returns that they offer, such activity may either be classified under-investment or the category of 'Other Assets / Miscellaneous Income.'
12. The amount of money for investing activities is relatively less and depends on the ability of the individual/ organization, but speculation requires large funds for executing the activities.

One should not mix speculation with gambling. Both these terms will often be used together, giving an impression that it means the same, but it is not. Gambling involves putting in money on an event that has an uncertain outcome in hopes of winning more money without any calculation.  It is purely a game of chance with the odds, not necessarily with the gambler.

For instance, a gambler will consider an American roulette game rather than speculating in the commodities market. However, the payout is only 35 to 1, while the odds against winning are 37 to 1.

Thus, if the bet is worth $5 on a single number, the potential income is $175, but the possibility of winning this amount is 1/37, and if the selected number does not arrive, the $5 is also lost.

Though most of the characteristics of investment and speculation overlap, one should understand the differences separating each other.

One should note that all investments are speculation, but all speculations are not necessarily investments. Both objectives are to earn profits; only the method involves a difference. There is nothing correct or incorrect in the approach, but it depends on the long-term objective of the individual and the quantum of risk they are willing to bear.

The truth of the matter is that every activity we perform involves speculation. The individual comes in the open and uses their judgment to forecast the future course of events and act accordingly. This peculiar psychology makes many investors avoid certain stocks or bonds due to their unforeseen possibilities, making investors judge safety by the yield and stability offered. If security is paying beyond a certain threshold, it is classified as 'speculative' and not for them.

Hence, one should be aware of the pros and cons of both these situations and keep awareness before arriving at any decision and not solely as an Investment or speculation activity. The element of gambling should also not be neglected entirely, and knowledge of the same should be kept in mind before arriving at any decision.

This article is a guide to Investment vs. Speculation. Here we discuss the critical differences between investment and speculation along with the infographics and comparative table. You may also have a look at the following articles –

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