Many people see investing as one of the main ways to grow wealth or make your money work harder for you.
There are a variety of ways you can invest, depending on the amount of funds you have and your risk appetite.
While some people may think investing is primarily buying into the stock markets. If you own a company’s stocks now, are you considered an investor?
One important thing investors overlook is the difference between investing and speculating. In this article, we look at the basics of what exactly investing is about.
This is essential to shaping your approach and investment strategy.
1) Risk Affects Speculators More Than Investors
There are many ways to define investing.
One way to set itself apart from speculating is to look at the risk involved.
Investing typically focuses on making sustainable returns over a period of time, considering the risk involved and requires some investment philosophy that’s based on fundamentals and analysis.
In contrast, speculation involves a form of short term opportunity that requires a risky bet – you might lose big or gain big.
Putting money into the trade may be due to an occasional event (company scandal/ change in government policies) and would probably be on a much shorter term basis as well.
2) Investors Benefit From Companies That Create Value
According to value investing guru Warren Buffett, an investment operation is where you make the decision to lay down some money now to get some more money back later on.
The decision is based mostly on value – what can the asset produce later on?
It can be a property, a farm or a company; the question an investor will ask before committing their funds is, can it produce more value than it has today?
The difference for him when it comes to speculation is that for the latter, it is more focused on the price action rather than the underlying investment.
As a speculator, you have the price in mind and you’d often find yourself thinking about whether the price of the stock is going up or down. In this sense, even buying into an index fund is considered speculation.
3) Investors Enjoy Better Principal Protection & Adequate Returns
“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative”.
Such is the definition provided by Benjamin Graham, whose book, “Intelligent Investor” is considered one of the best investment book for those who are new to investing.
A few guidelines he proposes to keep in mind that you are investing and not speculating includes:
- An investment should be something that you’ve analysed carefully and you know it will be stable in the long term.
- Your investment philosophy should be based on sound logic, not what’s popular on Wall Street.
- Don’t invest without knowing what you are buying.
With these in mind and having done some analysis on the investment you are looking at, you should be undertaking a calculated risk that still gives you a safety of your principal funds and some steady returns.
To Graham, an investor looks at a stock as part of a business whereas a speculator looks at a stock where is value is determined by what a potential buyer would pay for it.
While there’re no right or wrong ways to go about it (you can be an intelligent speculator as well), understand that investing requires some time and effort in order to keep that margin of safety.
With that in mind, this also means that it can be done by anyone who is willing to learn, reducing the risk you subject yourself to.