Investment and speculation are terminologies that are often used synonymously because of their similar features, but there is a line of demarcation to distinguish them.
To draw a clearer picture, assume 2 individuals, namely A and B, with distinct approaches. A is highly comfortable following the purchase and hold approach where financial instruments like mutual fund investment, stocks in stock market, real estate etc., are purchased and held for long term. A also takes a lot of interest and tends to review the stocks to buy today by regularly following a business daily that comes with a short column on stock market today. However, B prefers scalping and constantly opens and closes positions at the drop of a hat.
But it is not often as straightforward as the above example. What if someone holds a position for two years and after this sells it? Will it be considered a speculation or investment?
Check out here to know the distinction between the two terminologies
- Investment horizon
The obvious factor that puts investment apart from speculation is the investment horizon. Investment generally takes place over long-time horizons. It involves placing funds to work for many years or even decades for overall appreciation of the value of assets across the investment horizon. Note that it is not a situation of waiting with zero gains because investments may yield a stream of gains in the form of bond coupons, stock dividends and high returns from mutual fund investment.
Speculation, on the other hand, is a short-term depreciation or appreciation of the asset value to make instant profits and is not bothered by the potential of income it can generate over the long term.
- Potential to earn
Potential to earn in investment and speculation is often a debatable point. Speculators and investors both insist that their mediums are highly effective routes to earn huge profit. If clearly analysed, you will find there is zero guarantee of instant profits in case of speculation. But if your investment towards the market is consistent with income being reinvested regularly, you might avail inflation beating returns over the long term.
To place it in simple terms, speculation may be suitable for you if you want quick results while if you aim to generate high returns in the future to achieve financial goals, investment is the best choice. Either way, you will require high end knowledge about both concepts and discipline to attain success.
- Risk management
At this point, it may be clear that speculation holds a higher degree of risk. Reasons for higher risk is its shorter timeframe, which provides it with less time to recoup itself from market volatilities. On the contrary, as the concept of investment is usually long term in nature, such longer horizons permit more time to your investible funds to recover from market volatility, if any and make most of the compounding effect.
You can choose the SIP mode to invest in mutual fund. This mode enables automatic deduction of investible amounts from your savings account at regular intervals to ensure financial discipline. Doing this saves you from the perils of market timing because continued SIP in a mutual fund will average out your investment cost during the market correction phases.
Investing and speculating are 2 different activities of the capital or stock market. Risk factors, profit margins, methodologies, and fundamental strategy behind them are different. The above differentiation can be useful in determining your mode of earning as per your risk appetite and financial goals.