Whenever a person spends money to buy a security with the expectation of making a profit, he is either investing or speculating. The main difference between investment and speculation is the level of risk that the person undertakes as they attempt to make a profit from transactions they make in the market. Before getting into the difference between investment and speculation, let us first understand these terms.
What is investment?
Investment involves purchasing an asset for a long term to generate a certain amount of satisfactory return. In investment, the investor base his decision after thorough investigation of the soundness of the company to know the probability of success. Fundamental analysis, technical analysis and research is a key part of the investment process.
In general, investing means buying and selling of securities such as stocks, bonds, mutual funds and exchange traded funds (ETF) for a long term to get a good return. Investment in a company has following steps;
- Do a thorough analysis of the company for long term investment to know exactly what it is worth. Do not buy unless the stock is trading below its intrinsic value or has growth potentials.
- Understand the micro and macro economic impact on the business.
- Analyze the company’s financial statements and keep track of the key financial figures.
- Understand the company’s business and its competitors
- In case the market price of the stock drops, you should know the reason of such drop and be in a position to determine whether its a short term fall or has a long term impact based on the company’s fundamentals.
In simple terms, investing is the act of buying securities on the basis of careful analysis and holding it for the long term. To lower their risk, the investor may add several companies stock across different industries to the portfolio for a better return. Therefore, fundamental and technical analysis and research is the key to the investment process.
Return from securities can be in the form of appreciation in the value of underlying capital assets, periodic dividend, interest on capital invested or full return on the amount of capital.
Here is a list of financial tools that help investors to take an investment decision;
- Return on equity (ROE)
- Price to earnings ratio (P/E)
- Earnings per share (EPS)
- Price to book value ratio (P/B)
- Price earnings growth ratio (PEG)
What is speculation?
Speculation means allocating money into securities which has a high probability of failure. It involves the purchase of risky stocks to make profit from subsequent price changes. This means speculation is a financial transaction undertaken with the expectation of significant gain in which you may lose all of your capital if such transaction does not move according to your expectations. Day trading is a classic example of speculation. The potential of losing the entire or substantial portion of principal investment amount is known as speculating.
In simple terms, speculation means a person is trying to extract profit from price changes due to demand and supply forces. They buy stocks not on the basis of thorough analysis, but on the chances that it will rise from any cause other than a recognition of its underlying fundamentals.
A speculator has no emotion attached to the stock. They always have an escape plan if stock has fallen below a certain percentage from their entry position. A speculator is not bothered about the company’s fundamental value and instead focus on price movements. They are risking their principal amount.
In Security Analysis famous value investor Benjamin Graham along with David Dodd has said, “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
Investment Vs Speculation – Key differences
|Basis of differences||Investment||Speculation|
|Expectations||To secure stable return due to change in valuation based on the company’s fundamentals||A hope of profit from price movements due to demand and supply in the market|
|Time horizon||Long term||Short term, generally for less than a year|
|Base factor for putting money||Fundamental analysis, technical analysis and research||Market psychology, technical charts, opinion, tips of others, hearsay|
|Level of risk||Moderate or low, as chances of getting positive return over a period of time is high.||high, as the odds of losing money are greater than the odds of winning.|
|Attitude of investor||Cautious or conservative||aggressive|
|Avenues||Stock market, mutual fund, bank deposits, provident funds and other investment options||Commodities market, future contracts, put and call options, short selling, foreign currencies, cryptocurrencies, betting|