Are you an investor or a speculator?
You may not be sure, but the two are quite different. The primary difference lies in the safety of the principal. The first rule of investing is not to lose money. Therefore, your primary goal is to protect your principal. Speculation, meanwhile, focuses on the rate of return instead of preservation of capital.
Speculation gets a bad rap, but speculating is not always a bad thing. Some of the world’s greatest investors are good speculators. And, in my opinion, every young, aggressive investor should definitely do some speculating.
Let’s take a look at what it takes to become a good speculator.
1. Good speculators don’t chase growth.
Foolish speculators in the real estate market drove housing prices up to record highs only to see the bubble burst when housing prices came crashing back down to reality. Housing prices have been depressed for the past four years—a long way from their record highs of the early 2000’s.
Speculators drove up oil prices to almost $150 a barrel before seeing the commodity retreat back to the $50’s. Gas prices hovered near $4 in many metropolitan areas and it seemed as if those high prices were here to stay. Now, gas prices are below $3 a gallon and oil is priced at $80 a barrel.
Speculators drove tech stocks to inflated prices that were unsustainable. Companies that had never even made a profit were trading for hundreds of dollars a share. When it became evident that the Internet bubble had burst for many of these companies, speculators saw their portfolios wiped out. In all of these cases, speculators chased risk at any cost and paid dearly for it.
The lesson? Do NOT chase growth at any cost!
2. Good speculators don’t pass up great opportunities.
It is okay to take on more risk if the potential gain warrants it. If you want to make money investing, you must have an acceptable level of risk that you are willing to take. Without some level of speculation, investors can miss out on golden opportunities.
Smart speculators scooped up shares of Netflix (NFLX), Chipotle Mexican Grill (CMG), and Apple (AAPL) in their early growth stages. Many of these speculators have become multimillionaires because of these prudent investments. Short term speculation can be dangerous, whereas long term speculation can reward the patient.
Take Warren Buffett. His deployment of capital in General Electric (GE) and Goldman Sachs (GS) was part investment and part speculation. Buffett had no idea if these two iconic names were going to go under during the crash of 2008. But he took a chance and it has paid off big time. He has reaped billions of dollars in profits from his risky investments.
The lesson? Great investors do their homework first and then take a risk when the opportunity presents itself.
3. Good speculators don’t gamble.
There is a clear delineation between gambling and investing. Gambling is rolling the dice and trying to get rich quickly. Buying cheap penny stocks, trying to guess short term stock movements, and making big bets on rumors are all forms of gambling. There is no fundamental thesis behind these investment decisions. Proper speculation involves researching an idea and finding data that supports your investment decision.
The lesson? You must be able to defend a speculative investment. If you can’t, you’re gambling.
Even the most basic of investment decisions involves some speculating. Investing in blue chip stocks involves looking at past returns and speculating that a company will be able to duplicate those results. Small cap investing entails trying to forecast the future earnings of a company.
When you look at it this way, anytime you make an investment with the goal of achieving a future gain…you’re speculating. That willingness to speculate—along with some ability to do a good job—has made many successful investors and will, unquestionably, make many more.