Blurring the Lines Between Investing and Speculating

Oct 8, 2021 06:32 PM ET
Blurring the Lines Between Investing and Speculating

Over the last decade or so, the world of investing has changed dramatically. Although this practice has always inherently been risky, investors have taken it to a whole new level through what we call speculating.

The tricky thing is blurring the line between investing and speculating, as the two all have the same goal of generating profit. Debates continue over whether certain instruments like stocks and cryptocurrencies are either real investments or pure speculation.

Case in point, Bitcoin is arguably the one asset where people are still divided to this day over whether it is investing or speculating. Tesla is another example of a financial instrument stuck in the same battle. 

Unfortunately, there is no universal technical barometer to determine if something is an investment or speculative in most cases. The perception of both is usually discretionary. On the bright side, we can still observe some noteworthy distinctions between the two, which this article will explore further. 

Defining investing and speculating

The act of investing is purchasing an asset like a stock, bond, currency, or other financial product with the expectation of generating some profit in the future. 

We undertake the concrete investigation of the investment based on sound logic to estimate the probability of success and the potential profit. Profits from investments come in the form of capital appreciation, interest payments, and dividends.

Interestingly, anyone could argue speculating attempts to do the same thing, even when the asset in question might be structurally flawed with a high chance of failure.

However, there is no special predictive method of knowing if something will fail or not beforehand. After all, no sane person invests in something with the expectation of not potentially yielding a profit over time.

Yet, someone could speculate in something that turns out to be wildly profitable, while another could invest in an asset that turns out to flop despite initially showing promise.

Ultimately, one of the main determinants for better distinguishing the two is the level of risk between the two. Risk is the more objective differentiator between investing and speculating.

The risk differences between investing and speculating

When we invest in a financial asset, we generally look to buy something with a solid track record that offers appropriate returns with not too much risk. Moreover, an investor should seek to buy and hold the financial product in question for at least a year or longer.

On the other hand, speculative investments face a higher probability of losing a lot of money for the investors, though with the potential to deliver unusually high returns. This distinction is one of the reasons some literature equates speculating to gambling.

Many strongly oppose this notion as, like investing, people will perform their most educated due diligence before deciding. One popular financial instrument which many consider speculative is Bitcoin. 

Although the cryptocurrency technically has a relatively solid track record with years of existence, many experts are rarely inclined to call it an investment despite producing the best returns of any market in history. 

So, how come assets, particularly cryptocurrencies, have the 'speculative label' on them? Another key difference between something seen as an investment and speculative is the fundamentals driving that financial product.

The intrinsic value debate between investing and speculating

Most people see instruments like cryptocurrencies as being way overvalued. When analysts observe this rise, they will tend to throw around words such as 'intrinsic value' or 'fundamental value' and whether something like Bitcoin's high price is grounded in noticeable fundamentals.

There is a firm belief in blockchain technology, the potential for future disruption, low supply, and high demand. Yet, most argue the value of Bitcoin is mostly hype-driven.

There is no universal method of calculating the so-called intrinsic value of a cryptocurrency such as Bitcoin, which is one of the main reasons many call it speculative. 

Some even believe cryptocurrencies don't need to have fair value but rather purely supply and demand. When there is a lot of subjectivity, most will tend to lean on something being speculative. 

Let's look at a more objective example. One popular stock many have called a speculative bubble is Tesla. Like Bitcoin, Tesla has existed for many years. 

The company has only recently started making profits, yet many consider it somewhat unstable because of missing production targets, the stiff competition in electric vehicles, etc. Most argue much of the astronomical rise for the brand is pure frenzy and the media influence of Elon Musk.

Since going public in 2010, the stock has risen over 9 000% and is presently valued at $717. Interestingly, however, Tesla's true intrinsic value is only around $10, raising questions over whether it's an investment or just speculation.

Hence, an investor will want to compare the fair value and present market value of an investment and look for any mismatch to determine the risk involved.

The time debate between investing and speculating

The other distinction between investing and speculating is the time horizon. As briefly mentioned, investors plan to hold an investment for a year and never seek quick gains (slower growth). On the other hand, speculators have a shorter time threshold as they expect a tremendous increase (faster growth).

In speculative endeavors, people expect the investment to quickly double, triple or multiple more in price over a relatively short period. With pure investing, it is quite the opposite. 

Final word

It's fascinating to note how the prices of many investments in recent history have risen way above their fundamentals. At the same time, we have also seen how it has become easy for 'late' investors to lose money as they jump on the bandwagon.

However, it is not to discount so-called speculative investments entirely since tremendous gains are still worthwhile. Hence, it makes logical sense for investors to have some so-called speculative products in their portfolio but only forming a small or reasonable part. 

Ultimately, what some consider investing and speculating is highly subjective. What will decide this question for anyone is accounting for as many variables as possible while generally accepting any investment's inherent risk.

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