One of the most common errors that people make with their finances is that they think they’re investing, when in fact they’re speculating. Speculating is not investing. They’re two completely different things. They look and feel the same, but they’re quite different.
Speculating vs. investing is something I talk a lot about in my paid podcasts, but today I’ll give you the basic overview.
Investing is when you invest money to make the average rate of return of the typical, normal return for current market conditions. Historically, and for most of my life, this number has been around 7% or 8%. Today, in our slowly darkening, uncertain world, most good financial planners agree this number is around 5%. Therefore, investing means you plan on making about 5% on your investments and not much more than that. It means you’re investing in normal things, to make a normal return, without taking too much risk.
Speculating is very different. When you speculate, you invest your money to beat the average rate of return, usually by a lot. You don’t want 5%. You want 14%, or 22%, or 170%, or 500%. Speculating means you’re investing in things that are at least slightly outside of the norm by taking on more risk to make more money.
If you invest in a broad-based stock mutual fund or buy some long-term government bonds, you’re investing. If you invest in real estate in Malaysia, you’re speculating.
Speculating isn’t bad. If you’re very careful, do a lot of research, and stay very rational and calm, you can make a decent amount of money speculating. I speculate myself from time to time, and I’ve made money doing it, though it’s not my normal practice. My normal practice is to invest rather than speculate, since I always follow rule number one of investing: DON’T LOSE MONEY.
However, you can split your money into two buckets: one bucket for investing, where you expect to get around 5% for your money and not risk it, and another bucket (which is hopefully much smaller), where you can speculate and try to make big returns while knowing that you might lose it all. This two-bucket strategy is what I do.
How big your speculation bucket is depends on your age (the younger you are, the more risky you can be with your money), your personality (financially conservative or risky/exciting), how many kids you have or plan to have (kids mean you have to be more conservative with your cash), and your savings/investment goals. As just an example, I’m in my mid-40s, very conservative financially, have kids (though they are grown), and have significant savings/investment goals. Thus, my speculation bucket is quite small as a percentage of my overall investments. But that’s just me. You may be different.
The bottom line is to remember that when you are attempting to make more than the average rate of return (which today is only a pathetic 5%), then you are speculating, thus risking your cash, no matter how safe or “a sure thing” you think you’re investing into. That’s neither good nor bad; just be aware of what you’re doing and don’t bullshit yourself.