What is the difference between investing and speculating?

By Joseph Nguyen AAA
A:

The main difference between speculating and investing is the amount of of risk undertaken in the trade. Typically, high-risk trades that are almost akin to gambling fall under the umbrella of speculation, whereas lower-risk investments based on fundamentals and analysis fall into the category of investing. Investors seek to generate a satisfactory return on their capital by taking on an average or below-average amount of risk. On the other hand, speculators are seeking to make abnormally high returns from bets that can go one way or the other. It should be noted that speculation is not exactly like gambling because speculators do try to make an educated decision on the direction of the trade, but the risk inherent in the trade tends to be significantly above average.

As an example of a speculative trade, consider a volatile junior gold mining company that has an equal chance over the near term of skyrocketing from a new gold mine discovery or going bankrupt. With no news from the company, investors would tend to shy away from such a risky trade, but some speculators may believe that the junior gold mining company is going to strike gold and may buy its stock on a hunch. This would be speculation.

As an example of investing, consider a large stable multinational company. The company may pay a consistent dividend that increases annually, and its business risk is low. An investor may choose to invest in this company over the long-term to make a satisfactory return on his or her capital while taking on relatively low risk. Additionally, the investor may add several similar companies across different industries to his or her portfolio to diversify and further lower their risk.

For more on diversification, take a look at Diversification: Protecting Portfolios From Mass Destruction.

This question was answered by Joseph Nguyen.

RELATED FAQS

  1. How can retirees protect their wealth in a bear market?

    Look at some helpful hints about how to protect your retirement nest egg when the stock market is underperforming or the ...
  2. When is it beneficial for underwriters to sell stock below the minimum rate?

    Learn when selling stock below the minimum rate can be beneficial. Find out how the 1987 market crash affected an offering ...
  3. How do REIT managers use capitalization rate to configure their portfolios?

    Learn how REIT managers use capitalization rates to help assess risk and identify properties as potential purchase and sale ...
  4. What are the risks associated with investing in the railroads sector?

    Learn about risks relating to investing in the railroad sector. Explore how the price of fuel, cost of labor and access to ...
RELATED TERMS
  1. Smart Beta

    Investment strategies that emphasize the use of alternative weighting ...
  2. Complete Retention

    A risk management technique in which a company facing risks decides ...
  3. Alternative Risk Transfer (ART) Market

    The portion of the insurance market that allows companies to ...
  4. Investment Income Ratio

    The ratio of an insurance company’s net investment income to ...
  5. Adjustable Feature

    Contract language that allows adjustments to be made to the premium ...
  6. Development To Policyholder Surplus

    The ratio of an insurer’s loss reserve development to its policyholders’ ...

You May Also Like

Related Articles
  1. Trading Strategies

    Rise and Shine With This Pre-Market ...

  2. Professionals

    Why Investors Need to Rebalance Their ...

  3. Trading Strategies

    5 Ways To Adapt To Tough Markets

  4. Personal Finance

    What Exactly Does A Portfolio Analyst ...

  5. Personal Finance

    Credit Risk Analyst: Boring Title, Great ...

Trading Center