What is the difference between investing and speculating?

Investing, Asset Allocation
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3 weeks ago
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This is a great question, in part because it has no easy answer. Personally, I define speculation as the use of money (to purchase an asset) where the purchaser is prepared to lose 100% of the asset value, even if such an outcome is not likely. Presumably, the speculator would only accept such risk if the potential rewards were viewed as substantial and, in some sense, commensurate with the very real risk of a total loss.

An "investor," in contrast, expects with a high likelihood to preserve and enhance the overall value of the asset (or portfolio) over the relevant time horizon. Time horizon is critical here. The same asset could be viewed as highly speculative in one time horizon, and a prudent investment in another. Here's an example. Someone who buys an S&P 500 exchange-traded fund (ETF; for example, SPY) at 10 am and plans to sell it at 11 am arguably is speculating. Although a total loss is virtually impossible in the one hour holding period, conversely there is no strong theoretical or empirical basis for placing a high likelihood on experiencing portfolio growth over that hour. It's more like a coin toss.

In contrast, a 21-year old with a Roth IRA can make a reasonable argument that putting 100% of the Roth IRA in the same ETF and holding it for 50 years has a very high likelihood of leaving the investor well ahead in the end. Of course, even a 50-year holding period is not a guarantee of profit, but this is a case where I would argue that the ETF is a speculation over a one-hour hold and an investment over a 50-year hold.

3 weeks ago
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June 2009
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