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Investing vs Speculating: Do You Really Know What You’re Doing?

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Ryan Ong

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Newbies tend to use terms like “investing” and “trading” interchangeably. But that really doesn’t make sense (unless you’re one of those people who can’t see the risk difference between, say, starting a side-business and smuggling crack across the Mexican border). Nor is risk the sole determining difference here. Here we look at what you need to know to make sure you’re not flushing your hard-earned savings down the drain:

 

The Three Speeds: Investing, Trading, and Gambling

Think of money making methods in terms of a chauffeur, who drives at three speeds:

  • Won’t go above 50km/h, gives way to everyone, and gets stuck in traffic from doggedly following the GPS. You may be late (Investing).
  • Impatiently switches lanes to overtake, and tries to dodge traffic or find the shortest route. May get you there earlier than intended…unless the tactics result in getting lost, or an accident  (Trading).
  • The “chauffeur” is actually a cruise missile that you’re strapped to. Almost invariably comes to an explosive end (Gambling).

Here’s how to go at each speed:

 

1. Investing

Investors rely on the combined powers of time and compounding interest. They’re often referred to as “passive”, because they’re the financial equivalent of moss – they just sit there and collect. They feed on dividend payouts, rental income, etc., and usually use the money to re-invest in more of the same thing.

Examples of investing are:

  • Buying index funds or blue-chip stocks, and collecting dividend pay-outs
  • Buying commercial or residential properties, and collecting rental income
  • Buying bonds and collecting money from the coupons (interest)
  • Buying physical gold and stashing it somewhere, as a hedge against inflation

One advantage to investing is the low amount of decision-making required. An investor may decide to buy or sell every five to 10 years. A trader (see point 2) may have to make such decisions every month or week.

To use an engineering analogy, investing is a financial approach with few moving parts. The more decisions (moving parts) a financial approach demands, the more likely you are to make a mistake and “break” it – think of how much more likely your car or iPad is to malfunction, compared to a spade.

Investors also favour stability over high returns, and pick assets like blue-chip stocks. These companies / funds are at a low risk of collapsing, so the investor’s capital is well protected.

The downside to investing is that it usually takes a long time to pay off – we’re talking retirement planning here. And while investing can ensure you don’t go broke, it’s unlikely to ever make you a multimillionaire.

 

2. Trading / Speculating

Traders rely on a wide range of tools, from tactical asset allocation (timing the market) to speculating with futures and options. Underneath the complexity and Wall-Speak though, they’re basically just shopkeepers – they buy stuff and sell it for a profit.

Traders want to minimise risks, while maximising returns. They might do things like:

  • Buy stocks in a fast-growing company, and hope to sell at a higher price in a few months or days
  • Buy options to purchase an asset at a given price, on a particular date (e.g. if they think the price of silver is going up next quarter, they might buy an option to purchase silver next quarter, but at today’s prices.)
  • Actively trade currencies, in order to make money off the differences between the rising and falling strengths of each currency

I can’t describe all the pros and cons of trading in one subsection, any more than I can fit the Singapore zoo into my kitchen. Suffice it to say that trading can result in fast returns. What investors make in a year, a decent trader could make in a month or two (though a trader can also lose as much in the same time).

Trading is a complex financial approach, which requires a grasp of fundamental and technical analysis. It’s not generally accessible to lay investors, and can be stressful even to professionals. Follow us on Facebook for more on not getting burnt, if you’re a first-timer.

 

3. Gambling

Gamblers purposely seek out odds that are stacked against them. Just take a while to process that. The guy in front of a jackpot machine, or a Blackjack player hitting on a 19 (why would you even do that??), both know they are more likely to lose than to win. They don’t care, because they (1) can afford the loss (hopefully), and (2) are aiming for huge, instant gains.

Note that gamblers are not the same as traders. A trader will still try to minimise risks; traders generally avoid buying shares in a company on the edge of ruin, or bonds from a serial defaulter. A gambler however, might deliberately look for such assets.

Gamblers hope for the one-in-a-million chance that a dying company will bounce back, or that they’re one of the few creditors a junk bond issuer won’t default on. Their approach is, in effect, a socially acceptable form of Toto addiction.

Gamblers might:

  • Buy shares in a company that’s trying to turn itself around with untested products or management styles
  • Attempt to flip properties by transferring the Option to Purchase (giving them a week or so to find buyers willing to pay more)
  • Help fund a start-up with no business history, and with a product that’s entirely new to the market, because hey it might work!

Gambling rarely pays off; again, the gambler is more likely to lose than to win. The upside is the size and immediacy of the gains, along with the thrill of gambling.

 

How do you draw the line between speculating and investing? What principles do you abide by? Share your wisdom with us here!

Image Credits:
Oxfam International 

 

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Ryan Ong

I was a freelance writer for over a decade, and covered topics from music to super-contagious foot diseases. I took this job because I believe financial news should be accessible and fun to read. Also, because the assignments don't involve shouting teenagers and debilitating plagues.