INVESTING; UNDERSTANDING THE DIFFERENCE BETWEEN INVESTING AND SPECULATING

UNDERSTANDING THE DIFFERENCE BETWEEN INVESTING AND SPECULATING; AND MOST INVESTMENTS ARE MERELY GAMBLING

DIFFERENCE BETWEEN INVESTING AND SPECULATING;

Let’s consider an example with real life happenings:

We have 2 ten year old children each having a $100 in possession.

Amy uses the $100 to buy lemons, sugar, an old table, and some poster board and sets up a lemonade stand on a busy road. Business is brisk, and she reinvests her profits by buying more supplies. By the end of the summer she has turned $100 into $500. Some days (rainy, cool days) business was slow, some days (the hot sunny ones) it was brisk. She was never discouraged. She did not throw up her hands on the first rainy day and say “no one is ever going to buy lemonade again – I’m going to sell my stand”. She is an investor.

Johnny on the other hand goes and spends his entire $100 buying lemons, which he hopes to sell to Amy next week at a higher price. He heard the price of lemons will go up because the forecast is calling for record heat and lemonade is popular in the hot weather. Lo and behold, the forecast is wrong, the price of lemons drops, and Johnny is wiped out. Johnny is a speculator.

Speculators are forever trying to be smarter than the market. Investors simply participate in the markets. Speculating is akin to gambling. Investing is like going to work.

Investing is trying to find a reliable positive return on capital while reducing the risk to that capital. It is not altogether difficult, but the returns are low, and so it takes a longer time frame, frequently calculated in decades. Most investors meet their goals, and few lose money. It is a positive sum game, it is good for the economy, and is generally uncontroversial.

Speculating is trying to get the maximum return on capital, and accepting a much higher risk of negative returns or loss of capital. It is much more difficult, and luck plays a part, but the returns are high, and can occur over a short period of time (years, months or even days).

Many speculators lose, but many win. It is a positive sum game (if you diversify and speculate on everything, you’ll likely make a small, fairly reliable profit), is often good for the economy (that is how many new businesses are created and destroyed), but is somewhat controversial (the losses can be painful for employees, investors and speculators alike).

An investor calculates what a stock is worth based on the value of an underlying business, but a speculator gambles that a stock will go up in price mainly because someone else will payer even much more for it.

Some basic components of investing include:
a) Thoroughly analyze a company and the underlying business
b) Deliberately protect yourself against serious losses.
c) Aspire to “adequate” and not “extraordinary” performances.

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