Investments and speculation are often mistaken for each other.
In this post i will answer the question, what’s the difference between investing and speculating?
The difference between investing and speculating can be very confusing, because the two terms are almost the same.
What are Investments exactly?
An investment is an asset or item that is purchased with the hope that it will generate income or appreciate in a future day.
In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth.
In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price.
Investments aren’t only buying stocks, bonds and commodities and hoping that it will generate income.
An investment may also be going through a college or university, and thus getting an education so you can make more money in the future.
In the financial sense investments include the purchase of bonds, stocks, economic commodities or real estate property.
What are Speculations exactly?
Speculation is the act of trading in an asset, or conducting a financial transaction, that has a significant risk of losing most or all of the initial outlay, in expectation of a substantial gain.
With speculation, the risk of loss is more than offset by the possibility of a huge gain; otherwise, there would be very little motivation to speculate.
Speculation is not only confused with investments, but is also often confused with gambling.
The key difference between speculation and gambling is that speculation is generally tantamount to taking a calculated risk and is not dependent on pure chance, whereas gambling depends on totally random outcomes or chance.
Be sure not to get ‘making an investment’ and ‘speculating’ confused.
Investing usually involves the creation of wealth whereas speculating is often a zero-sum game; wealth is not created.
Although speculators are often making informed decisions, speculation cannot usually be categorized as traditional investing.
It may sometimes be difficult to distinguish between speculation and investment, and whether an activity qualifies as speculative or investing depends on a number of factors, including the nature of the asset.
The expected duration of the holding period, and the amount of leverage.
For example, while acquiring an additional property (in addition to one’s principal residence) with the intention of renting it out would qualify as a genuine investing activity.
Buying half a dozen condominiums with minimal down payments for the purpose of “condo-flipping” would undoubtedly be regarded as speculation.
Speculation has its benefits in a free economy.
By their willingness to assume the other side of the trade (for a price, of course), speculators provide market liquidity and narrow the bid-ask spread, enabling producers to hedge price risk.
Speculative short-selling may also keep rampant bullishness in check and prevent the formation of asset price bubbles.