The economics of the household aren’t great. Not only do you need to keep a reasonably good-paying job for at least four decades, but also you need to plan for a period of your life, say the last third of it, where you may not be able to earn a good living and have to live off what you have saved.
It’s hard enough to fund one You, but you need to fund two of them: Current You and Future You.
You can’t just put money under your mattress either; you’ll never have enough. Instead, you have to put it to work. And the method with the longest positive track record is investing in the stock market. (Though not actual stocks.)
It’s not an exciting prospect. Investing 15% of your money and returning a long-term average of between 6-8% for 30+ years isn’t exactly a page-turner of a story.
If only there was something better, easier, faster, some way where you could shorten the duration. A way to grow your money 200%, 300%, 500%.
This is an understandable desire. But it’s important to know that you’re moving away from investment and into the heady world of speculation.
Psssst, I’ve got a stock tip for you.
There’s this company called Tiddlywinks, and they are about to blow up. They are going public, and everyone’s going to want to be involved. But if you get in first, you get to reap the big rewards. You don’t want to miss it.
If it seems like I’m offering a throwback to the IPO tech boom, you’re not wrong.
But let’s look at what is going on here. If you were to get in on the Tiddlywinks offer, you’d be, in effect, guessing that the price would go up, and go up fast. It is a kind of bet, a wager.
If you’re right, and you time it correct, you could win (note the word) a pile of money.
If you’re wrong, you could be out that pile.
Now, you could do research to back up your claim. Maybe Tiddlywinks really is a game changer. Maybe their financials look good. But even still, you are making an educated guess, which is still a guess.
That is speculation.
How to tell speculation
But wait! How is that different from investing in the stock market, buying mutual funds? Aren’t you just “guessing” that the market will go up?
The first difference is level of risk. If you throw money into the stock market, you might indeed be guessing that the market will go up. But if it doesn’t, you’re not going to lose most or all of your money. You’ll lose some, temporarily.
For example, the largest percentage crash of the S&P 500 in my adult life was on October 15, 2008, when it lost 9% in a single day. It took two years, but it rebounded to that point, and now it is valued at more than double what it was then. So even if you sold at the bottom, you would have only lost 9%. And if you didn’t, you wouldn’t have lost anything.
Now, compare to your trading of Tiddlywinks. If the IPO doesn’t take off or it flames out, you may lose almost everything.
But that still sounds like the difference between mutual funds and stocks: increased risk for a potential increased reward.
So here’s the other difference: the timeline for speculation is much shorter. If you’ve got a mutual fund, your objective is to buy and hold for the long run. You participate in the market, become a part of it, work within it.
Not so Tiddlywinks, right? The plan there is to get in, make a pile, and get out. You’re not excited by the prospect of buying Tiddlywinks for the next 30 years, right? Nope, you want the return, and you want it now.
And there you have speculation. Investing is focused on the long-term, while speculation searches for short-term wins.
The biggest problem in this investment-versus-speculation debate is that people will often use the wrong word. Some people will say that they’re investing when what they’re really doing is speculating. (People don’t tend to confuse things in the other direction.)
So it’s important to really question the details when someone talks about investing:
- Did someone “invest” in a second house in the pure hope of selling it when it goes up in value? That’s not an investment.
- Most of the talk of cryptocurrency such as Bitcoin is not investment but speculation.
- “Invest in penny stocks?” Wrong.
Know the difference
Let’s admit that these distinctions are not always clear.
For example, some extremely risk-averse people think that even entering the stock market is akin to speculation, because of the assumption that the economy is going to collapse.
But the market at least has a long-term track record. And I’m old enough to have gone through at least one big crash where I worried that it would collapse. They said “this time it’s different”. It wasn’t.
I understand the desire to want to make big returns. It’s no fun to talk about 7% returns when you can talk about 300% returns.
But here’s the thing: you’re not going to get 300% returns, and if you do, it’s luck. It’s like winning the lottery. And you know how I feel about the lottery.
Let people talk about the latest tip or fad. Let them day trade. Let them flip houses. Let them speculate. Let them be “exciting”.
Meanwhile, you and I will be boring investors. And we will win over the long term.
But enough about me. Have you ever speculated before? What happened?
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