Investing and Speculating

The primary difference between investing and speculating is the amount of risk undertaken.
Investing vs Speculating
3 min
02-July-2024<br><br>

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.

Also read: What is 80-20 Rule in mutual fund

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).

Also read: What is portfolio rebalancing?

Examples of speculative investments

Speculative investments generally involve high risk but also provide high rewards if market movements are favourable. Here are some of the most common speculative investments that traders usually opt for.

  • Penny stocks
    Penny stocks are shares of small-scale companies that trade at very low prices, often below Rs. 10 per share. Since the price movements of penny shares are often very volatile and are not based on strong fundamental or technical factors, they are considered to be speculative investments.
  • Derivative contracts
    Derivative contracts are financial instruments that derive their value from an underlying asset. The underlying asset can be an equity stock, a market index, a commodity, or even a currency pair. There are two different types of derivative contracts available: futures and options. Derivative contracts use leverage, which enables traders to control large positions by depositing a fraction of the trade value as a margin.
  • Art and collectables
    Art and collectables are popular alternative investments that are speculative. The value of these assets is not based on any fundamental factor but rather relies on the perceptions of interested individuals.

Crucial differences between investment and speculation

As an investor, you must understand the differences between investing and speculating to make well-informed purchase decisions. Here is a detailed overview of some of the crucial factors differentiating the two approaches.

  • Risk management measures
    Although investment and speculation require the use of risk management practices, there is a major difference between the methods employed. For example, investors use techniques such as diversification and asset allocation to protect their investments from adverse market movements. Speculators, on the other hand, use risk management measures like stop-loss orders and position sizing.
  • Research and analysis techniques
    Investments require a comprehensive analysis of fundamental factors like financial statements, industry trends, and macroeconomic indicators to make informed decisions. Speculation, however, involves focusing on the technical factors of an asset, like price patterns and market trends, to predict short-term movements.
  • Susceptibility to emotions
    Investments are not susceptible to emotions since investors usually tend to maintain a more disciplined approach, persisting with their investment strategy even when the markets are turbulent. Speculation, meanwhile, is very susceptible to emotional decision-making due to short-term market volatility.
  • Use of leverage
    Leverage allows for the control of a large position with just a small amount of investment. Investments usually do not use leverage, whereas speculation often involves heavy leverage in the form of margin trading to amplify potential gains. However, while the use of leverage can increase the profit potential, it can also significantly magnify losses if the market moves unexpectedly.
  • Income generation
    Long-term investments usually generate passive income in the form of rent, interest, or dividend payments. This passive income, when reinvested, often boosts the wealth-creation potential of investments. With speculation, there is no passive income, forcing traders to profit from price movements.
  • Impact on the market
    Large-scale investments, which are often carried out by institutional investors, can stabilise the markets by keeping volatility in check. Speculation, especially when conducted on a large scale, can lead to a spike in market volatility and the formation of an asset bubble.
  • Regulatory scrutiny
    Although investment activities are also subject to scrutiny, market regulators often tend to view them more favourably. Speculative activities, meanwhile, are subject to strict regulatory scrutiny due to their increased potential for losses and their ability to quickly destabilise markets.

Also read: What is inherent risk?

Investing vs Speculating: A detailed comparison

Here is a table outlining all of the key differences between investment and speculation that set them apart from one another.

Particulars Investing Speculating
Objective To build wealth steadily over time To capitalise on short-term market fluctuations in an asset
Time horizon Very long; may take years to generate wealth Very short; ranges from minutes to days
Risk tolerance Requires moderate risk tolerance Requires very high tolerance for risk
Strategies used Fundamental analysis and diversification strategies are often used Technical analysis, leverage and market timing strategies are generally used
Approach Conservative; focuses on undervalued assets Aggressive; focuses on price movements
Volatility Not very susceptible to short-term market volatility Very susceptible to short-term market volatility
Return generation Returns are gradually generated over a long period Returns are generated quickly at the cost of increased risk
Commitment Requires discipline and patience Requires frequent trades and active monitoring of the markets


Speculating vs Investing: Which one to choose?

Now that you are aware of the differences between investing and speculating, which of the two approaches should you choose? Here is something that can help you make a decision.

The choice between speculating and investing largely depends on the following four factors: financial goals, risk tolerance, investment horizon, and personal circumstances. Investing is generally more suitable for those looking to create wealth over the long term without taking on too much risk. The approach is ideal for major life goals such as retirement planning, home purchases, and financial independence.

That being said, speculation might be more suitable for those looking for short-term profits, even at the cost of taking on high risk. However, it is important to note that speculating requires a significant time commitment since it involves constantly monitoring the markets for short-term opportunities. This makes the approach ideal for individuals who are comfortable with the possibility of significant losses in pursuit of quick gains and can carry it out on a full-time basis.

Also read: Active vs passive funds

Conclusion

Investing and speculating are two entirely different approaches to wealth creation. The choice between the two must be based on your financial goals, time horizon and risk tolerance. If you have moderate risk tolerance and are looking for steady, long-term growth, investing may be the right choice. On the other hand, if you are risk-aggressive and seeking quick profits, you could consider speculating.

If long-term investing is what you prefer, the Bajaj Finserv Mutual Fund Platform can help. You can find more than 1,000 mutual fund schemes from some of the leading AMCs in India. Additionally, you can also compare mutual funds with one another and choose the one that fits your requirements.

Essential tools for mutual fund investors

Mutual Fund Calculator Lumpsum Calculator Mutual Funds SIP Calculator Step Up SIP Calculator
SBI SIP Calculator HDFC SIP Calculator Nippon India SIP Calculator ABSL SIP Calculator
Tata SIP Calculator BOI SIP Calculator Motilal Oswal Mutual Fund SIP Calculator Kotak Bank SIP Calculator

Frequently asked questions

What is the difference between trading and speculating?
The difference between the two approaches lies in how risk is managed. In trading, the risks are actively managed through various measures. With speculation, however, returns are prioritised and risks are not as extensively managed.
What is an example of speculating?
Purchasing the call option of an asset and expecting the price to increase in the future is an example of speculation.
What is the purpose of speculating?
The primary purpose of speculation is to generate quick profits by capitalising on the short-term price movements of an asset.
What are the various types of investments?
Stocks, mutual funds, bonds, real estate, bank deposits, Exchange-Traded Funds (ETFs) and gold are some of the most common types of investments.
What are the risks associated with speculation?
Speculation carries a host of risks, such as volatility risk, the potential for significant losses and susceptibility to market sentiment and trends.
What is the power of compounding in investments?
Compounding in investments is a phenomenon where the returns from an investment are reinvested to generate additional earnings over time.
What is the difference between day trading and speculation?
Day trading involves purchasing and selling financial securities within the same trading day. Speculation, on the other hand, involves taking up positions and expecting the price of the asset to move in a certain direction.
Are speculators and traders the same?
Although both speculators and traders aim to capitalise on short-term price movements for quick profits, there is a major difference between the two. Speculators often take much higher risks, hoping to get high returns. Traders, however, do not take many risks and focus more on managing them more effectively.
Is speculation good or bad?
Speculation can be both good and bad, depending on how it is approached. For example, speculating with proper risk management measures in place may help you get quick profits consistently. However, excessive speculation without proper risk management can lead to significant losses.
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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.