Last year, the Harris Poll conducted a survey about investing for the American Institute of Certified Public Accountants (AICPA) — with sobering results. Almost half of the survey's respondents (48%) said they believed that "a volatile market gives them an easy opportunity to make a profit." In addition, 28% who said they are involved in household investment decisions perform no investment research, and the majority (63%) of those who perform research do it quarterly or less frequently.
These findings suggest that many Americans could use a refresher course in the difference between investing and speculating. A warning about the threat that the latter poses to an investor's wealth is also needed.
No Promises
Benjamin Graham, known as the "father of value investing," described the difference between investing and speculating this way:
An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.
No investment truly promises safety of principal. There is always some risk involved. But investing strategies — including diversification, proper asset allocation and thorough research on specific companies, securities and sectors — advocated by Graham and other investing experts historically have been effective in reducing risk. It is also important to consider your risk tolerance and time horizon in determining the aggressiveness of your investments. A longer-term view substantially mitigates risk, even for more volatile investments such as stocks.
Speculation, on the other hand, often is based on market timing, hunches, tips and other strategies (including luck). Proponents attempt to earn significant profits based on short-term price swings. But the risk of loss is so high that speculation generally does not have a place in a financial plan focused on long-term wealth creation. There is substantial evidence that even professional investors, such as fund managers, generally lose money when they try to speculate.
Not Necessarily Bad
Speculation is not always a bad idea. So long as most of your wealth is invested prudently, dedicating a small portion of funds to speculative activities may be acceptable. But you should understand the risk and be prepared for the possibility that you could lose some or all of your investment. In other words, do not speculate with money you need. Talk to your advisor about the most appropriate investments given your situation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.