Investing and speculating may seem like two clear-cut and different practices at first glance. However, they are more similar than they appear, and they are both valid strategies used by investors and traders as they attempt to profit from transactions they make in the markets. Investment theory argues that the differences between investing and speculating, and the level of risk involved in any transaction are two fundamental points that any investor seeking to make sound decisions with their money should understand.

Investing vs Speculating: What’s the difference?

In the financial sense of the term, investing means the buying and selling of securities such as stocks, bonds, exchange traded funds (ETFs), mutual funds, and a variety of other financial products. An investment is an asset or item acquired with the goal of generating income or appreciation in the future.

Investors hope to generate income or profit through a satisfactory return on their capital by taking on an average or below-average amount of risk. Income can be in the form of the underlying asset appreciating in value, in periodic dividends or interest payments, or in the full return of their spent capital.

On the other hand, speculation is a financial transaction that has substantial risk of losing all value, but with the expectation of a significant gain. Speculating is the act of putting money into financial endeavors with a high probability of failure. This practice seeks abnormally high returns from bets that can go one way or the other.

While speculating is likened to gambling, it is not exactly the same, as speculators try to make an educated decision on the direction of their trades. However, the inherent speculative risk involved in the transaction tends to be significantly above average. Of course, every investment carries some level of risk, but the potential of losing the entire principal investment amount is largely what differentiates investing from speculating.

Speculation usually carries a higher risk level because speculative trades typically involve leverage which increases risk, and because speculation is focused on shorter timeframes where market behavior is more dependent on random factors.

Other factors to consider that differentiate speculating from investing include time horizon, decision criteria and investor attitude. For example, speculative traders buy securities with the understanding that they will be held for only a short period before selling, so they may frequently move into and out of a position.

An in-depth look at speculating

Speculative trading does have its downfalls. When there are inflated expectations of growth or price action for a particular asset class or sector, values will rise. When this happens, trading volume increases, eventually leading to a bubble.

There are several types of speculative traders. For example, day trading is a form of speculation. Day traders don’t necessarily have any specific qualifications, rather, they are labeled as such because they trade often. They generally hold their positions for a day, closing once the trading session is complete. Another type are swing traders, who hold a position up to about several weeks hoping to capitalize on gains during that time by trying to determine where a stock’s price will move, taking a position, and then making a profit.

Speculators can make many types of trades, the most common being short selling, futures contracts, and put and call options.

You can’t outrun risk in the financial world

Even though speculating is a high-risk practice, investing that carries no risk almost always means that there will be little to no returns. Saving should be a key goal for all, but so too should be growing wealth. Simply stashing away earnings in a savings account won’t protect anyone against the destructive power of inflation, which is where investing and speculating come into play.