Speculating vs. Investing: How to Use Your Money Effectively
A dismaying number of people confuse investing with speculating. Recently I heard from someone who scolded me for advising clients to put all their money into the “Wall Street casino.” That is, into stocks. How wrong he was.
First, I never tell anyone to concentrate on one type of asset. Over the past 23 years, I’ve penned scores of columns about the benefits of a diversified portfolio of asset classes (stocks being just one of them). Still, I would far rather invest 100% of my retirement funds in a diversified portfolio of U.S. stocks than speculate on a roulette wheel. There is a big difference between investing and speculating.
I learned that difference the hard way when I was in my early twenties. I had some money in savings and some mutual funds in an individual retirement account, but they weren’t building wealth fast enough for me. Gold prices were up and going higher, so I took $1,000 out of my savings and put it into gold futures. In just a few days, my $1,000 had turned into $3,000.
My broker suggested putting the $3,000 into pork bellies. I didn’t really know what they were, but he seemed to know what he was talking about, so I bought pork bellies. For a few days, everything was fine.
Then the price of pork bellies tanked. For five days straight, the price fell so dramatically that the commodities exchange stopped trading at the beginning of the day. I couldn’t even sell. There was nothing to do except watch the losses pile up.
By the time trading resumed, I had a commodities margin call for $12,500 ($50,000 today, adjusted for inflation). In other words, I had to put more money into my account because the assets I’d acquired had shriveled so much in value. To pay it, I had to wipe out my savings and cash in my IRA. At least I had savings, so I didn’t have to borrow money.
I had made a classic rookie mistake—speculating instead of investing.
There are three things you can do with money you wish to set aside: save, invest or speculate.
Saving is putting money away for future needs, often in a bank savings account or certificates of deposit. The primary purpose isn’t building wealth; it’s having money when you need it for emergencies or large purchases.
Investing is diversifying money into stocks, bonds, real estate, commodities and other asset classes. The purpose is to accrue wealth over the long term, so investing is boring. While you will see the value of your money decline as well as increase, it is unlikely that over a long period you will actually suffer a permanent loss of capital. Your returns over time will probably be more than you would earn from simple savings.
Speculating is putting money into a high-risk investment in the hope of building wealth quickly. It’s exciting, dramatic and risky. Examples of speculating include trying to time the markets through day trading, putting everything you have into one investment and borrowing to buy stocks, real estate, or commodities.
True, some people made great fortunes through speculating, but many more lost them that way. Not only can you lose your initial investment, you can—as I did with my pork bellies—lose far more money than you had to begin with.
When novices skip from saving to speculating, chances are good that they’ll lose big. Unfortunately, too many of them learn the wrong lesson. They decide, “Investing is too risky,” never realizing they were speculating rather than investing.
As a result, in the future they may limit themselves to saving. Their money stays safe, but over time they lose a lot, especially through decreased purchasing power. Bank savings accounts and CDs pay minuscule rates. Investing is not a casino, but a means to earn the long-term returns that are so important for building net worth and achieving financial security.
Follow AdviceIQ on Twitter at @adviceiq.
AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.