Are you investing or speculating?

How to understand if you are speculating or investing

“Investment involves risk. Past performance is no guarantee of future results”. We have all seen this disclaimer when making any investments. If future results are of no guarantee, does that mean investing is speculating?

It might seem that way for some, but speculating and investing are, in fact, different. Let’s take a look at the differences:

1.Your trading/investing behaviour and frequency

When we are speculating (read: gambling) instead of investing, we are inclined to look at the markets more, and make sporadic trades rather than investing in a consistent manner.

This type of behaviour has been particularly apparent during this COVID-19 crisis, where a study by economists showed that retail investors increased their trading activity by approximately 13.9% for every doubling of COVID-19 cases.

At the end of the day, we have our own personal opinions on whether stocks or index funds are expensive or cheap, which may lead to trading behaviour anchored not on scientific reason, but on guesses. We may choose to trade in and out of the market more based on how many guesses we have, but the more we indulge ourselves with such thoughts and such behaviour, the more we are speculating, instead of investing.

Read more: Why passive investing beats trading

2. Whether you have an investment goal or objective in mind

When investing, we should do our budgeting, know how much we want to invest for our mid- and long-term goals, and how much to leave enough cash for short-term emergency funds. 

We should accept that it is innately difficult to time the market, instead, once we have established our budget or plans, we should be persistent to put that money at work (also known as dollar-cost averaging).

In contrast, a gambler (market speculator) would in some cases be leveraging up to try to outsmart the market on random bets.

3. If you have diversified your holdings

Spreading your investments over countries, sectors, and companies so that you are as diversified as possible, to get a better chance to capture economic growth.

The difference is diversification in investing is that the method is backed by science.

Diversification works best when the assets are either uncorrelated or negatively correlated with one another so that as some parts of the portfolio fall, others are likely to rise. This will offset the volatility of individual investments and spread out your risk.

The ideal scenario is when the price correlation across assets within a portfolio is at or near zero. That means the price movement of one asset will have no effect on the prices of the other assets.

Nobel prize-winning economist Harry Markowitz called diversification "the only free lunch in finance". His theory is that if you hold a portfolio of investments that are not perfectly correlated, an investor can lower risk without sacrificing expected returns.

Simply put, spreading your investments across asset classes and geographies gets you the same reward with less risk. That’s the free lunch.

A study done by Dimensional Fund Advisors shows that missing out on the top performers in the global stock market (weighted by market cap, across developed and emerging markets) will lead to significantly poorer returns.

By spreading your underlying exposure more thinly, you will have a lower chance of missing out on investments in companies that give higher returns, and hence give you a higher chance of hitting the 7-9% historical returns we can get from the equity markets.

4. Whether you focus on investment returns or costs

Market speculators and gamblers alike tend to focus on potential winnings and outcomes. To them, with the right strategy, the right timing, with an element of luck, they would be able to make a bigger earning based on their ingenuity.

However, for market speculators, such an "investment strategy" comes with both explicit (trading and transaction fees) and implicit costs (bid-ask spread, time spent on managing investments and transferring money). These costs may or may not lead to higher investment returns. If we realise that we are spending more transaction costs than we expect to, then we are likely to be speculating than investing.

Final thought: Invest with an evidence-based scientific framework to maximise your chance of investment success

Investors take a systematic approach to growing their wealth, buying assets with reasonable levels of risk in exchange for long-term growth. 

It’s important to know the difference, so you can properly manage the level of risk you take against your expected return.

With the digital wealth platform Endowus, you can plan and manage your money — by investing in Best-In-Class Funds and globally diversified, low-cost model portfolios seamlessly.

Click here to get started on your investing journey with Endowus Hong Kong today.

Read more:

• Why we are terrible at New Year's resolutions and forecasting
• How to invest your first US$100,000 or US$1 million
• Goal-based investing and why it matters

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Risk Warnings

Investment involves risk. Past performance is not an indicator nor a guarantee of future performance. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. 

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