Last week we covered the basics of speculating and investing. Now that you know the difference, it’s time to look at which is “better.” I chuckle about this because I am firmly in the “investing is better” camp. Yet, in the interest of objectivity, I’ll cover both here today. Stock speculation was a prevalent pastime in the bull market of the 2010s. Still, it became popular again with the coronavirus pandemic, with people looking for opportunities to make money during the quarantine.
Let’s begin by recapping the difference between trading and investing.
- Trading and investing are two ways to get involved in the stock market.
- Your ability to handle risk and the amount of time you have to invest your money before you need to use it are the two critical factors that can help determine which method is best for you.
- Investing means you will buy a stock with the expectation that its value will go up over time. In other words, you are going to buy and hold the asset.
- Trading is not about buying and holding; instead, it is about following movement in the stock market and making purchases and sales in short periods in the hopes of making profits quickly.
OK, now that we’ve had a little review, let’s weigh the pros and cons of speculation.
The Pros of Stock Speculation
While market timing or speculation is precarious, people do it because it can mean big profits. While investors are happy earning 8-10% on their investments a year, traders aim to make 8-10% a month! Consider that a trader that averages only 5% a month could potentially earn a 60% compounded annual return. However, things don’t always go according to plan, do they?
The Cons of Stock Speculation
Speculative stock trading is a risky business for several reasons.
- You have to make quick decisions with limited information.
- These decisions are essentially taking an educated guess, the equivalent of gambling to some degree.
- Unless you are a professional trader, it is challenging to monitor multiple trades at the same time.
- This makes it hard to create a diversified portfolio, and because of that, the balancing effect diversification can have on investments is mostly lost.
When is Speculation Not Speculation
At the end of the day, neither strategy is better because of one simple fact. Investing is not that black and white. Even active investing requires watching market trends and buying at what may be more opportune times. Look at Warren Buffet, he is a buy-and-hold kind of guy, but he makes calculated decisions about when to get in and out of specific stocks.
We must also consider the difference between active and passive management. Now, I’m not going to get into a long discussion about active and passive management, but there is an essential factor at play here. Active management, to a degree, employs speculation. The motive is different; instead of looking to take risks to make large returns, active managers are looking to beat benchmarks in their specific sector, style, or weighting - think mutual funds here. A large-cap mutual fund manager will be looking closely at the S&P 500 and Dow Jones to make calculated investments. This isn’t speculation; it’s active management. On the other hand, passive management is buying and holding the same stocks as a specific index attempting to mirror that index’s return, think ETF.
There are ways to use stock speculation and investing responsibly, and that is what I want to leave you with today because taking some risk for potentially increased reward is ok depending on what stage you are in in your financial life. For example, some investors put almost all their money in a well-diversified portfolio but keep a tiny percentage of money aside to “play” or speculate with.
However, if you had to decide between one approach or the other, if you are risk-averse, you should invest for the long term, if you are comfortable with risk and willing to take on more of it for the potential to earn more money, then speculate away.
I want to be clear here, however, that I firmly believe in investing and making educated decisions using the information each of my clients provides, research on various investment vehicles, and the analytical tools available, to make the very best suggestions I can for each client’s portfolio. I truly believe that slow and steady, the tortoise versus the hare approach is the smartest approach to investing.
Stay tuned for Part 3!
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Until next time…
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes.
Investing involves risks including possible loss of principal. No strategy assures success or protects against loss. All performance referenced is historical and is no guarantee of future results. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market. Bonds are subject to market and interest rate risk if sold prior to maturity.