Speculators are often in the news, either through making a fortune from plummeting currencies or betting against failing companies.
But what is investment speculation, exactly? And is this an investment strategy that you should be considering?
More to gain, more chance of losing
Speculating is the process of making very risky investments in the anticipation of getting very high returns. It tends to be a short-term strategy, which hopes to take advantage of large fluctuations in a stock or market.
Speculating falls somewhere in-between investing and gambling. Although there is a high risk of failure, it is a calculated risk. It could involve the chance to gain 10 times your investment, but at the same time you could have a 90 per cent chance of losing it all.
Why is speculating so risky?
Speculators look to make big gains in a short period of time. Solid, safe investments are unlikely to bring those kinds of gains. Therefore, speculators tend to choose unproven, polarizing, or distressed companies that are more likely to see big price swings in the near term.
A recent example is the buying of marijuana stocks. Buying them a few years ago would have been very speculative as the drug was still illegal recreationally and might never have been legalized.
Even with it becoming legal, the problem from an investor’s viewpoint is that marijuana companies don’t yet have a track record post legalization. Profitability is still a big question mark. They could have poor management, run out of funding as investor interest dries up, and go under at any time. Plus, the industry is so young that the potential for growth or loss is unknown.
While speculators have to be prepared to lose their whole investment, most professional speculators are aware of the risks and have exit strategies to minimize losses. They will bet small amounts with big risk attached.
The difference between speculating and investing
A key difference between speculating and investing is the individual's time horizon. If you invest over a long period of time, the chances are that you will see positive gains. Investors typically have balanced portfolios of different stocks to minimize risk, but over a short time horizon, even a diversified portfolio of stocks can be viewed as speculating.
Buying an investment property is a great analogy to highlight the difference between investing and speculating. An investor would buy a rental property with the intention of keeping it for a decade or more. This allows time to ride out any market crashes and also gather recurring income from rent. The speculator will buy a property with the intention of flipping it and making a quick profit. If the market crashes just after they buy it, they could stand to lose a lot of money.
Is speculating just a get-rich-quick scheme?
Some investors may look at it this way. If, for example, your friend persuades you to invest in their tech start-up, this could make for a quick return. However, businesses with no sales record have a high chance of failure.
For professional speculators, it is not just a get-rich-quick scheme. Although they are looking to make money quickly with each trade, you can speculate with small bets to control risk and be viewed more like a rational investor.
Should I speculate?
Speculating requires a lot of effort, knowledge, and often luck to be successful. Relying solely on luck and ignoring the first two is gambling. Investing on the other hand, doesn’t require much effort, knowledge, or luck. If an individual invests regularly into a diversified portfolio and doesn’t touch it, all that’s required is time and patience to bring success.
If you do want to speculate, be prepared to lose your investment. Don’t put more than 5% of your portfolio into it, and look at it as entertainment rather than a way to make big bucks. For example, you should never put all of your money into something like marijuana or bitcoin. It would be very difficult for your investments to bounce back from those losses.
For personalised advice, talk to your ATB Wealth financial advisor about your goals and the best way to achieve them.