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Investing vs. Speculating

We live in an age where instant gratification is the norm. From fast food to on-demand streaming, we have become accustomed to having everything at our fingertips with little patience for delay or inconvenience. This mentality has seeped into the world of finance, with many individuals seeking quick and easy ways to make money in the markets.

Just the other day during my daily commute to work, I noticed many fellow commuters on the subway checking out charts and their daily profits and losses on their phones. It got me thinking – do these people have any process or idea of what they are doing at all? I asked my friends how they were allocating their hard-earned cash. This got me some interesting insights that can be grouped into two categories:

1 - The Conservatives

These individuals are afraid of the market and therefore hold their cash primarily in their savings accounts and/or fixed deposits. Unfortunately, in times of high inflation, this conservative approach means a guaranteed loss of the value of their hard-earned savings.

2 - The Courageous Gamblers

This group of individuals is more aggressive and puts their cash to work in primarily the equity markets. Not a bad idea – but I quickly realised they were buying and selling equities without following any form of investment process. In a way, this approach holds many parallels to gambling. Investing in heavily promoted stocks, this group faces occasional and temporary incredible successes. Sadly when the tide turns they typically end up with severe losses and may be forced to sell at the worst possible moment.

💡 People in this segment are prone to buy stocks based on promoted stock tips faster than they would buy a new phone or watch!

In our attempt to earn a quick buck, most of us resort to some form of gambling and we needlessly stress ourselves out by constantly checking the markets and making decisions without really knowing why.

Do not worry, these are not the only categories! I have identified two more categories that I will introduce today: “The Thoughtful Investor” and “The Calculating Speculator”.

Financial charts used by investors and speculators.

The thoughtful investor thinks independently

Contrary to what people like to think, investing is not a get-rich-quick scheme, but rather a calculated and thoughtful process that requires time, effort, and discipline. Most of you will have heard investment mantras and expressions such as “a bird in the hand is worth two in the bush”, “stocks are riskier than bonds” and “buy low, sell high”. Modern society keeps repeating these mantras and expressions without evaluating their meaning. Well, let me tell you this: investing is first and foremost a thinking exercise. So let’s get into a practical definition I personally use to explain what investing is.

Investing is the process of paying out cash now to buy an asset that you predict will produce more cash for you in the future with the intention of holding the asset forever and for a price that gives you a margin of safety for taking on the risk.

Let’s break that down a bit further to make it more practical!

  1. Process means a proven and logical set of steps you take to make informed decisions.

  2. Asset means a piece of ownership of an item that puts cash in your pocket. For example a profitable business, a profitable stock (part ownership of a business), a bond or real estate.

  3. Predict means a best-effort estimate based on the historical performance of an asset. In other words, there is no 100% guarantee. It is useful to design your own set of filters to figure out whether you can confidently predict the future cash flow of the asset. This is a topic I plan to discuss at length in a future blog post.

  4. Future typically means 10-30 years. The intention of investing is to buy and hold the asset forever. We will discuss the topic of selling an asset in the future.

  5. Margin of Safety simply means you want a discount (or buffer) to protect yourself from losses due to miscalculations and unforeseen events resulting in some form of future decline in earnings power.

  6. Risk means loss of capital or getting insufficient return on investment.

The Calculating Speculator needs a solid trading plan

Speculation is easier to define. This does not make it easy though!

Speculating is the process of intelligently anticipating asset price movements with favourable risk reward characteristics.

Once again, let’s break it down:

  1. Intelligently anticipating means applying a proven strategy to identify favourable price moves.

  2. Favourable risk-reward characteristics mean that you need a process and trading plan that sets you up for success. Important components of this trading plan are the probability of winning a bet, a pre-determined loss per bet and a profit per bet you are targeting. In practice, this typically means that you want the targetted profit per bet to be multiples of your pre-determined loss per bet. And please remember, speculation is based on probabilities, winning 100% of the time is a fantasy.

Let me be frank. Although I’m primarily investing these days I have done my fair share of speculation as well (forex, CFDs, options, futures, crypto etc.). You can actually engage in both! The key message I want to bring across is that you need a clear process in place to ensure you are set up for success. There is certainly merit in both investing and speculating – both can be enormously rewarding!


Thank you for reading!

The Financial Dutchman


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