Investing vs. Speculating

By Paul R. Ruedi, CFP®

 There is a thin line that separates investing from speculating. Two people may buy the same stock and while one is investing, the other may be speculating. Though I’m not exactly sure where the line is drawn, there are usually two things that set them apart. The first is time horizon. But the second is even more telling: the justification for buy and sell decisions.

Investors take a long-term approach. Instead of buying a stock, they view themselves as taking partial ownership of an actual business. They tend to be more focused on long-term buy-and-hold investing strategies. They commit to a company or investment for the long haul and will reap whatever dividends or returns the company produces over that time period.

Speculators, on the other hand, generally look to make money on large, short-term price swings. A speculator buys a stock not necessarily committing to ownership of the company, but with the intention of riding a price swing and eventually selling it to someone who will be willing to pay more for it later.

That last line contains the most common justification that allows speculators to abandon all sense, “I’ll be able sell it to someone else at a higher price later.” Other speculators will convince themselves they know the “correct” price of a stock, and will set themselves up to profit when the market eventually gets smart and moves to the “correct” price. But assuming the market is dumb now and will be smart later is a troublesome assumption.

There are many problems with speculating, perhaps the most obvious is that people can completely blow themselves up taking senseless risks with the intention to dump their positions on a greater fool later. Sometimes that greater fool never shows up, and the fool is you.

From a planning perspective, speculation as an investment policy is impossible to build a financial plan around. When a portfolio is committed to buying and holding thousands of stocks for a long period of time, you can use what we understand about the nature of stock returns to build a financial plan around that portfolio. This is completely impossible for a speculator. You simply can’t build a plan around random investment picks and unpredictable buying and selling.

You can tell by the tone of this column I think long-term investing is a better idea for investors. If you find yourself making investment decisions that depend on finding a greater fool to bail you out later, you may want to think again.

Paul R. Ruedi is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.