Here’s how to tell the difference … and when it’s actually OK to speculate in the stock market.
Do you feel hesitant to put more of your money in the market because it feels like a gamble? Even seasoned investors can get nervous about investing their hard-earned money, because all investments come with risk.
SEE ALSO: What Will the Stock Market Do Next? That’s the Wrong Question
And for most people, the thought of losing the money you worked hard to earn is far more painful than the chance of possibly earning more.
But here’s the thing: If you’re investing wisely, you can mitigate your risks through the right strategies, like appropriate asset allocation and diversification. You still risk experiencing temporary losses, but it’s not the same as taking your cash to the blackjack table.
Some people, though, treat investing that way. They throw money into the market without a plan, without a strategy, and without the proper safeguards in place to protect against unnecessary risks.
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In other words, they don’t invest at all. They speculate, and they often experience wild swings and major losses in their portfolios as a result.
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What Are You Doing with Your Wealth?
Benjamin Graham wrote about how to identify a speculator in his great investment book, The Intelligent Investor. He explained that “the speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices.”
Graham goes on to write that investors do care about market movements — but only from a practical standpoint, not because they get emotionally involved with volatility. Movements in a market, said Graham, “alternately create low price levels, at which [the investor] would be wise to buy, and high price levels, at which [the investor] certainly should refrain from buying and probably would be wise to sell.”
Based on this definition, “investors” are not just individuals who put money into the market. Investors are people who purposefully, strategically and rationally buy and sell securities. Speculators, on the other hand? Those are individuals who also buy and sell in the market — but they do so emotionally and without a strategy.
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So, on which side of the spectrum do you fall? Are you investing or speculating?
If you’re unsure, consider this list of activities and behaviors. If you’re checking the boxes here, you might be speculating:
- You think about the short term. You’re trying to earn a big return in a short amount of time. Rather than planning to invest over years or decades, you want to see a return within months, weeks or even days.
- You act based on hunches, guesses or tips. No one knows what the market is going to do tomorrow (let alone any one individual security in that market). If you base your investments off of predictions, forecasts or what someone else told you was going to happen… that’s speculating, not investing. And yes, this holds true even if the hunch came from a so-called “expert” on a financial TV program!
- You let your emotions get the best of you. Humans are highly emotional, irrational decision-makers. There’s nothing we can do to change that — but we can plan for it by putting an investment strategy in place and then sticking to that strategy. If you abandon your plan in favor of your feelings, you’re probably speculating.
- You think you know more than the market. An efficient financial market means that the securities within that market are accurately priced. But speculators think they have some sort of information the rest of the market doesn’t have — and they try to use that information to find mispriced securities. If you think you know more than the millions of other market participants and all the data that flows in and out of that market to determine individual prices … A. you’re probably wrong, and B. you’re speculating.
If You Are Speculating … That Might Be Just Fine
Here’s the thing: If you realize you’re speculating instead of investing, that might be OK in some circumstances. Speculating isn’t inherently bad, but people run into problems when they leverage all their available wealth to do so or fail to realize they’re not investing.
If you use 95% of your available funds to invest wisely, you’re on track to meet all your financial goals, and you have the risk capacity (and tolerance) to be OK losing a small amount of cash on a speculative investment. It might be OK to take 5% of your available funds and go play.
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The key is to understand you’re doing just that: playing around, or making a gamble, or speculating. If you have the money available, feel free to speculate on the side — and make a distinction between that activity and your strategic investment plans.
Of course, some people do not have the capacity to speculate with any amount of their money. A good financial planner can help you determine what’s appropriate for your situation and provide an objective, third-party opinion on how much cash you can safely use to speculate with stocks, businesses or other vehicles like cryptocurrencies.
Your adviser might also be able to serve as the voice of reason needed to say, “OK, you’ve made a great return with your speculative investment — now, it’s time to sell.” Even when you’re exploring the possibilities with a small, safe amount of your wealth, it’s helpful to have a logical voice on your shoulder to help you make the most of both your strategic investments and your more speculative ventures.
See Also: The 9 Investment Risks You Need to Guard Against
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
