Speculating When You Think You're Investing

The other day I met some wonderful folks who own a gold mine right here in Colorado. They are using all their skills and knowledge in hopes that they'll strike it rich. This business provides their family a good life, mostly outdoors, and benefits that exceed the financial remuneration. But don't get me wrong, they are not investing. They are speculating.

A few weeks ago, I wrote about my friend who speculated on initial public offerings (IPOs) He didn't appreciate the risk he was taking until he realized the losses. All of the losses.

Speculating is not gambling. We have one friend who won a small fortune at the casino, which is so rare! We have met many people who have lost a fortune, inherited or earned, in the casinos. Gambling, without skill, completely dependent upon luck, is not speculating. Clearly, gambling is a fool's errand.

Speculating gives the appearance of investing. With research, experience, confidence, and other illusions of safety, a person mortgages the house and speculates on, say, the price of oil, gold and silver, or the effects of the upcoming presidential election on healthcare stocks. None of this is knowable. None of it you need to know to be a good investor.

Speculating is not investing.

How do I know I'm speculating and not investing? A speculator is taking big risks in business in hopes of making a sizable profit. If I think I'm going to make a large profit, I'm probably taking large risks. It's no more complicated than that. The size of the risk is the first sign of a speculation.

Speculation causes strong emotions. A key sign that you're speculating and not investing is that you feel excessively confident (or terrified). You have conversations with yourself that go like this: "Oh look, I knew this was a good idea. See that (advertisement, news story, person talking nearby) validating my opinion." You're looking for validation all the time: from the media, from your friends, on the radio. You have already made up your mind and when you hear news that differs from your opinion, you argue with it. You've heard repeatedly that this idea (Colorado marijuana business, for example) would be a good idea and you're sure that it (Bennigan's restaurants, for instance) will be enjoyed by everyone in America soon and you'll earn fantastic returns.

Speculation promises huge returns, so if you're worried you might be speculating and not investing, think about the returns you are hoping for. In the stock market, a diversified pool of investments will yield, over long periods of time, stock market rates of return. In a speculation, we feel assured that this particular investment (plot of real estate) will increase in value quickly because all our experience, skills, and research say so. But if we put enough money here to make a difference in our lives, then we've speculated.

A key sign of speculation is the number of dollars we've put into it. If this amount of money is large enough for you to make a killing (or be killed) by it, you've swapped investing for speculation. It's easy to do. Often, many people we know and respect are doing it alongside us.

Speculation sometimes happens inside our 401(k) plans. We allow our company stock to become a large portion of our wealth and before we know it, we've speculated our life savings on something completely outside our control.

Finally, speculation is the opposite of investing because investing is diverse. Diversification is humility in the face of the great unknown future. It's really just acknowledging that none of us know what the future holds. Investing is using all the skills, knowledge, experience required of speculation, plus a mandatory large amount of humility and integrity, and spreads out the best ideas in just enough portions to satisfy our financial appetites for a lifetime.

Read this recent press release from the CFP Board.

Investing for Yield Instead of Total Return
Leverage, All I Really Lost Was Time

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