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.

10 Comments on “Speculating vs. Investing

  1. Lucid explination Caleb, most investing information flies over my head majority of the time.

    Any resources you would suggest to get a better grasp of Investing/Economics?

  2. Any resources you would suggest to get a better grasp of Investing/Economics?

    Way too general a question. The internet and bookstore is full of this stuff. My general advice is go to the Motley Fool website.

  3. In today’s context broad-based stock funds or government bonds are anything but an investment. How can anyone justify buying government bonds? Who expects to benefit from loaning money to a bankrupt institution AT CLOSE TO 0% INTEREST? This can’t last

  4. Who expects to benefit from loaning money to a bankrupt institution AT CLOSE TO 0% INTEREST? This can’t last

    Exactly. It can’t. And it won’t.

  5. As someone pointed out, if psychics could predict the future, why aren’t they all billionaires? *You* have to put the work in when you speculate. There is no point hoping someone else will do it for you, because that person if they were indeed psychic, would be making their own money. Choosing speculative investments well is the job that a venture capitalist does – they supply capital to risky ventures. It’s actually a hell of a lot of work, a full-time job.

  6. [quote]
    Exactly. It can’t. And it won’t.
    [/quote]
    John Maynard Keynes said, “The market can stay irrational longer than you can stay solvent.”
    [quote]
    As someone pointed out, if psychics could predict the future, why aren’t they all billionaires? *You* have to put the work in when you speculate. There is no point hoping someone else will do it for you, because that person if they were indeed psychic, would be making their own money. Choosing speculative investments well is the job that a venture capitalist does – they supply capital to risky ventures. It’s actually a hell of a lot of work, a full-time job.
    [/quote]
    J.P. Morgan said, “Millionaires don’t have astrologers, billionaires do.”

  7. Now I get why we wouldn’t agree, Mr Jones: You are wrong with your fixed bar set at 5%. I’ll show you:

    According to your definition, buying stocks in the most overvalued moment in History is “investing” as long as I don’t expect more than 5% per year.

    However, investing when stocks are cheap, like early 2009, would be speculating to you? The cheaper you buy something, and thus the greater expected rate of return, the more “speculative” it is to you!

    This is nonsense.

    You told me for some reason that buying cheap countries was speculative. It isn’t, because the expected (historically-informed) rate of return in THOSE countries is way above 5%. Your 5% would be applicable at a certain moment to a certain market (and in a 10-year horizon it’s 0% at the moment for the US: https://www.hussmanfunds.com/wmc/wmc170313.htm)

    Your quasi-estatic “5%” is the typical BS spewed by financial media. It is a mathematical fact that when stocks drop by half the “5%” becomes “10%”, but by the time people have lost that much money only Doom&Gloom sells and no one thinks about updating the number to a more rosy perspective.

    Do this test (I know you love these long-term challenges): Next time stocks lose half their value from the top, ask any good financial planner about HIS expected rate of return, and see how many have increased it in at least the same ratio that stocks have dropped.

    Let me propose another definition for investing vs speculating: Speculating is to rely on the asset appreciating to make money (flipping homes), whereas investing only requires that profits keep coming until the investment pays for itself (rental home with positive cash flow), or a stock held for the long term (payments in form of dividends or buybacks, doesn’t matter). Notice that a 2% dividend requires 50 years (100/2) for the stock to pay for itself. That is why, if stocks are expensive (if dividends are small relative to price, like the current S&P500 at 2%), everyone 40 years old and older is speculating if they buy now. They will die before they see a decent return on their investment.

    Unfortunately, no one will tell them.

  8. You are wrong with your fixed bar set at 5%.

    That is not my figure. That’s the figure often quoted by conservative financial experts.

    I understand that the Societal Programming in the financial community may be inaccurate; that’s always a risk, but we have to start somewhere. The 5% figure isn’t an exact number; you could argue that the real number is 6% or 7% or maybe even 8%, and I won’t argue with you, because I don’t know what the precise figure is with exact certainty (and neither do you). I just know that figure is low.

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