Investing Vs Speculating: What Is the Difference?

Investing Vs Speculating: Investing and speculating have very different connotations. One gives the impression of thoughtful, evidence-based decision-making, and the other implies wild risk-taking in the hopes of making a quick buck.

Is there truly a difference between investing and speculating? If so, what are the advantages and disadvantages of each?

What Is The Definition Of Investing?

Any investment carries a certain amount of risk. There are no “sure things,” which is why every investment prospectus includes language to the effect of “past performance does not guarantee future returns.” 

In the stock market, a company’s fortunes can change without warning. For example, organizations like Enron and Nikola (NKLA) lost value overnight when scandal erupted. Enron never recovered, and Nikola is still struggling. In both cases, investors lost extraordinary amounts in a matter of days. 

Sometimes, sudden drops aren’t unique to a specific business. The March 2020 market crash affected almost every publicly-traded company, including seemingly “safe” investments like Amazon (AMZN), Apple (AAPL), Alphabet (GOOG), Facebook (FB), and Microsoft (MSFT). The five lost a stunning $416.63 billion combined over the course of a few tumultuous hours and over $1.3 trillion in a month.

Despite the possibility of dramatic setbacks and the strong probability that investments will have a certain amount of volatility, those who put money into these types of companies after careful evaluation of the risks and potential benefits qualify as investors.

In short, while there are no guarantees, investors have determined returns are more likely than not after thoughtful consideration.

What Is Stock Market Speculation?

Stock market speculation is an entirely different approach to the stock market. Speculators choose trades that have little chance of success, knowing that if they do succeed, the returns will be astronomical.

Think of it like sports betting. When you pick a team with low odds of winning, you will probably lose your money. But if you do win, your payout is far higher than it would have been had you bet on the league favorite. 

Speculation is based on rumor, guesses, gut feelings, and blind luck. In some cases, speculators buy high-risk stocks, but they are more likely to choose options, futures, and short selling strategies instead. These tools make big profits possible, but big losses are more likely. 

Short-selling may be the best illustration of the risk associated with untempered speculation. This technique involves borrowing shares, selling them, and – assuming the price goes down – buying them back at the lower price when it is time to return them to their owner.

The problem is that there is no cap on the risk associated with short-selling. In theory, stocks can increase by an unlimited amount, and short sellers remain obligated to buy it back at the new price.

This differs from investors who buy stock for the long-term, because there is a limit to how much can be lost. Stocks can drop to a value of zero but no further.  

How Does Speculation Differ From Investing?

At its most basic, investing is a calculated risk. Those who participate typically begin with research. They examine a company’s fundamental health from a financial perspective, a management perspective, and an industry perspective to determine whether the stock is more likely than not to provide a rate of return that meets the investor’s financial goals. 

For example, a fundamental investor interested in buying shares of Amazon (AMZN) will examine its revenue growth and earnings prospects.

Speculating works differently. It is best defined as big risk for the possibility of big rewards. Odds are that the bet won’t pay off, but if it does, speculators will enjoy a windfall of cash.

Many liken stock market speculation to gambling, and it generates a feeling similar to a gambler’s endorphin high. That keeps speculators going, even when they are risking more than they can afford to lose. 

It is worth noting that some of the most famous and infamous speculators didn’t exactly follow the rules in their dealings with the market. In some cases, they exploited loopholes to exact returns, and in others, they committed outright fraud.

These are the folks that tend to inspire less sophisticated speculators to take unreasonable risks. Their use of less-than-ethical methods to build their fortunes gives inexperienced speculators the mistaken impression that success is a likely outcome. 

Is Investing Better Than Speculating?

In a head-to-head matchup between investing vs speculating, the winning method depends almost entirely on your goals.

If the purpose of participating in the stock market is to grow your assets and reach specific financial objectives, investing is the only way to go. While some investments will probably miss the mark in terms of returns, a well-rounded investment strategy mitigates risk. 

For example, investors tend to hold at least some of their stock in well-established multinational companies with a long history of success. Just consider the enormous value accrued by investors who stayed the course in behemoth companies like Apple (AAPL).

In addition, they diversify their holdings to ensure the strength of their portfolio isn’t dependent on a single asset. These strategies may not deliver astronomical returns, but they rarely result in deep losses. That makes them wise for investors who wish to build wealth for the long-term. 

Speculating tends to be a more short-term operation. Many speculators only hold assets for a day. These are known as day traders. Swing traders use similar methods, but they hold assets for a slightly longer period – perhaps a few days or weeks. 

There is nothing wrong with a little speculation, as long as it is undertaken with the right mindset. It can be exhilarating to risk an affordable amount in hopes of a big win, but it’s rarely a workable long-term financial strategy for all but the most talented and committed of traders.

A small number of day traders and swing traders see long-term success, but the vast majority lose everything. 

How is Trading Different Than Investing?

It is common to hear the terms trading and investing used interchangeably, but this is misleading. Yes, investors trade stocks when they buy and sell assets, but in terms of style, traders have more in common with speculators than investors. 

Trading as a strategy indicates short-term positions. Traders buy and sell quickly – for example, day traders and swing traders. Investors, on the other hand, hold their positions long-term, which in this case means a year or more. 

Traders are focused on beating the market by profiting from short-term changes in market conditions. This is rarely related to a company’s underlying health and future prospects.

Instead, it has to do with perceived patterns in market activity over the course of the holding period. Given the short time frame involved, traders tend to spend much more time on creating and executing strategies than their investor peers. 

Is Trading More Profitable Than Investing?

The reason people go into trading is that they believe it will be more profitable than investing. For example, while an investor may be attempting returns that meet or exceed the average of approximately six percent per year, traders might attempt to reach five percent each month. 

For the few who are successful, trading is more profitable in the short-term. However, it doesn’t build long-term value. As soon as the trading activity stops, so do the profits.

A more likely scenario is that traders never realize profits – and in fact, they lose some or all of their capital. That’s why brokerage firms require traders to demonstrate that they have access to a certain amount of capital before they are permitted to participate in this type of market activity. 

The bottom line is that speculating and trading should be viewed as expensive hobbies. It is unusual – and downright unlikely – that they will deliver substantial income over time.

Investing is a must to protect assets against a variety of risks that reduce portfolio value over time – for example inflation. That makes thoughtful investing an important part of any long-term wealth-building strategy.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.