Investing vs. Speculating

By Twickenham Advisors on August 18, 2017

“[T]here are two times in a man’s life when he should not speculate: when he can’t afford it and when he can.” Mark Twain

I keep hearing people talk about investing in Bitcoin, Ethereum, or some other crypto-commodity. Of course, you only hear about the ones that make a ton of money; not a word about the losses. But I don’t want to write about Bitcoin today, although (don’t worry), I do have some thoughts about it. I am writing today about the words “investing” and “speculating.”

You see, when someone tells you about “investing” in Bitcoin….they really should use the word “speculating” instead. What is the difference and why does it matter? Please, one question at a time.

Both investing and speculating involve buying or selling. The purpose behind the buying and selling is what separates the two.

Investing is buying a share of a company, a bond, real estate, farmland, etc. with the purpose of owning a share of free cash flow, interest, rent, or crop yield. In investing, there is an expectation of yield.

Speculating is buying something with the thought that somebody else will pay you more for that object at a later time. If the object you are buying doesn’t yield anything, or at least have the potential to yield, you are almost invariably speculating. Why else buy? Speculative purchases include Bitcoin and gold but can also include stocks if the purpose behind buying a stock is to later sell at a higher price.

Indeed, there are elements of speculating in investing and vice versa. While investing in the shares of a company to buy a share of the underlying assets and a share of the free cash flows, you are speculating that the future cash flows of the company are sustainable.

So, why does all this matter? Well, perhaps, I am too sensitive about the use of the words, but I do want to share some benefits to investing vs. speculating. I believe, as Seth Klarman put it: “[…] [I]nvestors have a reasonable chance of achieving long-term investment success; speculators, by contrast, are likely to lose money over time.” Investing is patient and analytical. Speculation is impatient and emotional.

This is because speculating has no basis for price. For instance, the price of Bitcoin is now $4,380. This value cannot be derived by applying a multiple to the earnings or by comparing the yield to other investments. The price is based purely on what others will pay for it at this point in time. But because there is no yield, much like Tulip Mania / Tulip Fever, there is nothing to stop that price from going to $1,000,000 or $0. It is pure speculation.

Benjamin Graham may say it best, “[p]eople who invest make money for themselves; people who speculate make money for their brokers.” Ted Warren further clarifies this perspective saying, “[t]he percentage of casualties among speculators is unbelievable. Over a period of time, they have little chance. They are very much like those who bet on the horses.”