This debate between investment versus speculation is never ending. But I would like to present a case here from my perspective.
So first thing first? Why we invest money?
We invest money to build wealth.
But by speculating with our money (instead of investing) we are not building wealth.
Buying low and selling high concept in share market makes money only for our brokers. Not for us.
So Benjamin Graham states that, you are investing only if you are doing the following: 1) Analyzing shares before purchase, 2) You are assured of the safety of your principal, and 3) You are assured that you will make some returns
Before buying any share, ask yourself if these three conditions are fulfilled or not.
If answer is NO, buying that share will be speculating and not investing.
There is difference in the approach of an investor and speculator.
Investor “calculates what a stock is worth”. Speculator just “gambles” with a hope that the stock price will go up.
Suppose you bought stocks of a company. Due to some reasons the share market closed for next 1 month. How you will behave?
A speculator, who is not able to see the stock prices every 30 minutes will perhaps die in anxiety.
But an investor, knowing that the underlying business of his stock is very strong, will live in peace.
It is no surprise that more people in this world play stock market like speculators. Like gambling and derby, speculating is stocks is more exciting.
But this is the “worst way to build wealth”.
In todays times people find it hard to believe that “day trading” and “investing” are two separate concepts.
Advent of online trading platforms has made day trading even more convenient. Hence this popularity.
But this is also true that speculating is a part of human nature. There will be times when you will become unreasonable and start speculating.
Hence suppressing it may not work. Better alternative is to become aware of this limitation and learn to contain this urge.
Hence this rule shall be followed:
Check the size of your investment portfolio. Suppose it is $10,000. Never allocate more than 10% (10% x 10,000 = $1,000) of your money for speculating.
Idea is is keep your speculating urges satisfied by allocating a small portion of your wealth to it.
Why speculation is so famous?
Ask a trader or a gambler and they will give you benefits of speculation as if it is the best invention of the world.
But unfortunately the blogger of this post is not a speculator. So you will have to be satisfied with only a very subdued praise of speculation.
We can clearly decipher two benefits of speculation.
To understand the first, lets take a hypothetical example.
Suppose you are Warren Buffett and you are living the times of 15-May’1997. Those were the days when AMAZON went public raised funds through IPO.
Back then who knew Jeff Bezos and Amazon? No one.
I am sure, even if Warren Buffett (you) knew Jeff Bezos, he would have still not bought even one share of Amazon.
But the fact of the matter is, Amazon does raise its funds in IPO. Moreover, it is one the words biggest, and well managed companies of the world.
If there would have been no speculators back in May’1997, probably Amazon would not have been what it is today. Thanks to the speculators, for investing in such a “untested, new companies”.
No do take me wrong. There is no sarcasm intended here.
But I am sure that, back then (May’1997), the so called speculators must have a very-very long vision. These qualities must have made then “Great Value Investors” by now. 🙂
The second benefit is related to keeping the market alive.
Stock market cannot survive if sufficient number of buyers and sellers are not present.
Only buyers will not help. Similarly only sellers will be of no help.
Preferably there must be justified number of buyers and sellers.
In stock market, whenever there is a stock transfer (from buyer to seller), there is an associated risk.
For the buyer, the risk is related to price fall. If market price of his purchased stock falls, he loses money.
For the seller, the risk is related to price rise. If market price of his sold stock rises, he loses the possibility to make more money.
Value investors hate this risk. Hence they invest very conservatively and less frequently compared to other type investors. But this less-frequent share trading may kill the stock market.
To keep the stock market live and kicking, there must be “rampant activity” going on in share market.
It is only speculators which keeps the share market alive and kicking.
Problems with Investment
All individuals face this dilemma between investment versus speculation. On one hand speculation looks like an easier skill to manage, but investment is a much tougher skill to master.
So it is only obvious that majority take the speculation route.
There is no denying of the fact that learning ‘stock investment’ is tougher than learning speculation.
If fact there is nothing to learn in speculation. Human beings are born as speculators, right? At least, it looks natural to me.
Apart from how speculation is easy and investment is tougher, there are two things that makes investment looks even daunting (but let me tell you, its all in the mind).
First, analysing stocks needs one to dig deeper into companies annual and financial reports. Reading these reports require some basic know-how of accounting.
Reading balance sheets, profit and loss accounts, cash flow statements, financial ratios is a must to evaluate stocks.
A person from non-finance background neither learnt about reading financial reports even in schools. This makes investment in stocks even tougher.
But let me tell you from my experience. This is not as difficult as it sounds initially.
You can read about how to find best stocks from this link. Or else, you can also read a series of articles on fundamental analysis published here.
The second problem with investment is that, there is tough competition around.
It is true that 90% people who put their money in stock market follow speculation approach.
But the 10% who really invest money as directed by Benjamin Graham is his book called “Intelligent Investors” are specially trained to do this tasks.
These are people who studies from IIT’s and IIM’s and are doing job as Fund Managers in big banks.
How can a common man like me and you can compete with them? They will have must easier access to information related to stocks, and moreover they are well trained.
So what a common man do?
The best advice for common man is to forget about the competition and focus on the real thing.
What is real thing?
“Buying stocks of fundamentally strong businesses at undervalued price levels”.
If we can do only this (consistently), we can beat even the best in the business of investment.
There are ways how one can do this. The safest best is to learn how to analyze stocks.
Final words on Investment versus Speculation
If we are not investing, we are otherwise speculating. There is a great risk involved with speculation.
So if one has to decide between investment versus speculation, a learned conclusion will be “investment”.
To ensure that you are investing, make sure you are analyzing your stocks before investing. As a result of this analysis, the invested money will remain safe. Moreover, the invested money will also generated positive returns.
To understand the magnitude of investment, lets take a small analogy between ‘wealth building’ and ‘health building’.
To build health (lose excess weight), people often take the dieting route. This is a short-cut to lose weight. And probably this why more people diet and loose weight.
But we know weight loss like this is not sustainable. Exercising is a more authentic way to loose weight. But achieving the target though exercise is both tough and time-taking.
Similarly, money made by speculating is not sustainable. Investment approach is a better alternative.