Investing and speculating are two vastly different approaches through which you can generate returns from the financial markets. Investing involves purchasing financial instruments, expecting them to increase in value or generate income over time. Speculation, meanwhile, involves purchasing and selling financial assets over the short term to generate profits.
Understanding the difference between investing and speculating is crucial to making well-informed decisions. In this article, we are going to delve into the concepts of investing and speculation and unearth the differences between these two approaches.
What is investing?
Investing is a wealth-creation approach where you invest your money in financial securities such as stocks, bonds or mutual funds with the expectation that it will grow in value over time.
Investors who use this approach usually have a long-term perspective and hold onto their assets for extended periods, aiming to build wealth gradually. Some examples of investment options include bonds, equity stocks, mutual funds, Exchange-Traded Funds (ETFs), real estate, annuity plans, bank deposits and money market instruments.
What is speculating?
Speculating involves taking up positions in an asset and expecting it to move in a particular direction. Unlike investing, speculation usually disregards the fundamentals of assets in favour of high-risk, short-term bets.
Traders following this approach are usually concerned only about generating profits quickly, even if it means taking on high risk. They thrive on volatile market conditions and use the momentum of the market to capture price movements. Some examples of speculative investment options include derivative contracts like futures and options, penny stocks, cryptocurrencies and commodities.
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Investing: An example
Let us now take up a hypothetical example to understand how investing works before moving on to the differences between investing and speculating.
Assume you are a 23-year-old individual wanting to accumulate a large enough corpus for retirement by the time you reach 60 years of age. You have almost 37 years to accumulate wealth. After carefully analysing the various investment options available and their fundamentals and other key metrics, you decide to invest in an equity-focused mutual fund via a Systematic Investment Plan (SIP).
Through the SIP investment, you plan to invest Rs. 10,000 each month consistently for the next 37 years. Assuming that the average rate of return of the fund is 9% per annum, you would accumulate approximately Rs. 3.57 crore at the end of your investment period.
Speculation: An example
Before moving on to the comparison between investing vs. speculating, let us quickly look at an example to better understand this concept.
Assume you wish to make quick profits. You identify a particular stock that has posted a less-than-ideal quarterly financial performance. Speculating that the price of the stock would fall in response to this, you decide to short-sell 1,000 shares at Rs. 85 per share.
As you expected, the price of the stock fell to Rs. 75 per share on the same day. You square off your position immediately and get a profit of Rs. 10,000 per share (1,000 shares x Rs. 10 per share).
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