Understand Speculation Versus Investing

Someone asked this question on Quora yesterday.

“What is the difference between investing and speculating?”

For many, speculating sounds like gambling and investing sounds like the adult way. Many people do both but do not understand the fundamentals of each. Success should use aspects of each.

I think the question is a good one and one that many people find confusing.

The distinction is derived from how you assess value and price

Warren Buffett has stated that to make money in the stock market you must know two things.

  1. How to value a business, and
  2. How to understand what market prices mean and how they develop.

“Investors” tend to rely on the first to be real and the second to be more ethereal. They buy when the market is pricing the security too low in their estimation and sell when the market is pricing it much too high. Their task is more like engineering. Understand how the pieces work and put them together is a way that provides value. Market prices force them to rethink value over and over again. Perhaps they were wrong before.

Speculators tend to deal primarily with the market pricing mechanism and essentially become players in a game where all other buyers or sellers are their competition. Their aim is to be smarter, quicker, or better informed than the others and gain advantages that way.

It’s possible that either method might work

The skills required to be a successful speculator are not easily acquired. John Maynard Keynes, who was a skilled money manager too, attributes success in this “to anticipating the anticipations of others.” Anticipating what others will think in six months is a very difficult task. Few people understand how future events will influence how people will act.

Understanding people and how they work is much harder than understanding businesses. Buying on business factors is manageable and you can adjust your holdings if those factors change. New management, serious competition, economic factors, and such. Maybe you can know when people will become pessimistic or optimistic or part of group hysteria, and act on that, but it’s not very measurable.

The idea of investing is to use your knowledge to make the capital accumulation process easier and more predictable. Speculating is complex and volatile but for people with the right skills and temperament, it could be lucrative. It is certainly more exciting and that is worth something to some people. The problem is the method is essentially produces events as opposed to being systemic. What you learn from one trade may not have meaning for another one in the future.

The skilled investor, as Buffett suggests, understand both methods and acts on what the market offers.

I help people understand and manage risk and other financial issues. To help them achieve and exceed their goals, I use tax efficiencies and design advantages. The result: more security, more efficient income, larger and more liquid estates.

Please be in touch if I can help you. don@moneyfyi.com 705-927-4770

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