- Posted by: Brighter Mind
- Category: Value Investing
Know the difference between investment and speculation
Investment and speculation are two sides of dealing in the equity markets. Both these terminologies look little similar as both involves buying the security for profits, but there is a line of difference between the two.
The major difference is related to the time horizon and the data backed decision. For instance, investment involves buying the security for the longer term with the hope of good returns over the period of time. While speculation is buying the security to earn quick profits by utilising the market movement or short term sentiments in the market.
When compared head to head, the objective of both investing and speculation is same i.e. to earn returns. But there are some below key differences which is important for the investors to understand.
- Decision Criteria
Investments in any security are done on the basis of extensive research. There are many fundamental factors including qualitative and quantitative research. Valuations and performance of the company is taken into consideration and the fair value is derived before investing in the company. So investment is the data-backed decision.
Speculation on the other hand involves decision based on market emotions. Market sentiments and psychology is understood before entering into any security. Generally speculation is based on the market trend and is done with an objective of making profit in shorter term.
- Time Horizon
Investment is buying the security and sticking to it for the longer term. When an investment is made in any company, investors have to be patient and control their emotions for long duration to generate good profit. Sometimes investment takes years to generate multi-fold returns, but that is the beauty of investing!
Speculation is generally short term. When speculators buy any stock and their target is reached, they exit from that stock and look for another opportunity. This target can be reached within a day, a week or even year. So speculation generally delivers outcome in very short period of time. But the returns in speculation can be positive or negative as it is purely based on the sentiments.
- Risk Involved
As investment is data-backed approach and is done for the longer term, the risk involved in this is moderate. Short term market sentiments do not play a vital role in deciding the returns on investments. The only risk involved in the investment is gap in research and buying the wrong security with poor fundamentals.
Speculation is done by the investor to book good profit in short term and hence involves high risk. Market volatility is the major risk in speculation and investor can look money in quick succession if the decision goes wrong. Also speculation majorly depends on news, rumour and gut instincts which make it more risky affair than the investments.
- Type of fund
For investment, investor uses their own funds which they can afford to keep invested for the longer period of time. Hence they are at peace of mind as there is no leverage involved in investments.
Speculation on the other hand can be done by own funds and borrowed funds as well. Generally speculators take margin from the brokerage houses so as to earn more returns in shorter span. Due to margin and leveraged money they can transact the higher quantity of shares than the actual limit which is allowed by their own funds.
Investor need to be patient and in control during entire investment horizon. Also, investor tends to carefully select the stock after all the extensive research and enter into the trade with conviction. They are more conservative considering their risk appetite and know their capacity to absorb risk.
Speculator on the other side is very aggressive in taking risks. The main objective of speculator is to generate extensive profit at maximum risks. Speculators know they might lose money or the capital invested if the decision is wrong, but they take such risks because of the lucrative rewards of higher profits.
Though the investment and speculation are overlapping, one must know the key difference between them.
Fundamentally, investment can be part of speculation but speculation can never be the part of investment. Even though the objective of both is same, there are certain factors which make them two sides of same coin.
Hence knowing the difference can help the investor to make the right decision while managing their hard earned money.