INVESTMENT can be defined as the process of putting wealth into assets, with an expectation of realising a higher amount from the disposal of these assets than the amount initially outlayed
When one opens a savings account, the intention is to earn interest, and thus realise a greater amount on maturity than what one would have put in.
Saving, therefore, is a part of investing. With saving, the return to be realised is known with certainty right from the investment’s inception (assuming the investee institution does not fail before the investment’s maturity).
Speculation on the other hand is defined as the outlaying of money into a risky investment, with the expectation of getting above-normal returns. The returns to be realised are not known with certainty at the beginning of the investment, and the possibility of partial or total loss is significant.
Speculation therefore also falls into the category of investment.
From the definitions above, it is clear that the distinguishing factor between these three activities is the risk and the potential returns. Saving is normally a risk-free option of investing, but it also gives the lowest return.
Speculation is the opposite extreme, offering potential high returns but also bringing in the possibility of negative returns. What we call “investing” is the halfway house; placing money into assets which are expected to yield higher than the traditional savings account, but at the same time exposing the investor to the least possible risk required to achieve this.
In practice, investing is achieved by putting together a combination of risky and risk-free assets (ie money market deposits and property with stocks, derivative instruments and other such risky instruments). Varying the proportion in which these assets are brought together in a portfolio enables the investor to manage the amount of risk they are taking. This process is known as “asset allocation”. If you invest in an all-stock, or an all-derivatives portfolio, (and typically pick one or just a few shares within these categories) we would classify you as a speculator. On the other extreme, if you invest only in the money market or real estate, you would be termed a saver, or conservative investor. The average investor would fall in between these two extremes.
Given these classifications, the question becomes which of these is most favourable. We generally recommend adopting a balanced approach, particularly for the average investor.
While there are individuals who will boast that they have been able to consistently “time” the market and have made a “killing” in the process, they are unlikely to tell you about when they were “killed”.
Achieving good results with a speculative strategy is also generally better done by active traders (ie those watching the market on a continuous basis, such as stock brokers, analysts and possibly asset managers/dealers), and insiders (insider trading is illegal, but it happens nevertheless).
The “outsiders” who adopt speculative strategies generally end up on the losing end, and in fact are the source of the insiders’ and traders’ abnormal gains.
The majority of people playing the stock and derivatives markets (known as “punters” in the trade) indulge in speculative investing without being aware that they are doing so.
Most people, when told that the stock market is experiencing a bull-run, rush to their nearest stockbroker and ask them which share they should buy in order to “make a quick buck”.
The middle of a bull-run is the most risky point at which to enter the stock market, as the possibility of prices receding on profit-taking is highest. It is generally the punters who in their bid to acquire shares at any cost, drive share prices up during the run.
Meanwhile, the insiders and the institutions are generally the ones selling at this point. By the time the bull-run ends, it is the speculators who will be holding the stocks and there will be no buyers as the insiders and institutions are aware that stocks will be overvalued.
Punters also tend to buy stocks with funds which they will need in the short-term, and thus they will not be able to continue holding their stocks when the market stops running. They then start to offload at any cost and prices go into free-fall. The insiders and institutions wait until share prices fall to below their intrinsic values once again before buying their shares back, and waiting for the bull-run cycle to begin again.
Saving, or conservative investing on the other hand limits investors’ returns, and where interest rates are sub-inflationary (as in our case), may actually result in erosion of value over time.
Our website gives further details on how one can implement a viable investment strategy that contains risk while optimising returns.