You could say the difference between investing and speculation is simply a matter of risk tolerance, with speculation being closer to gambling. The truth, though, is that there’s no clear cut line between them, as all investing carries risk. Still, there are differences worth knowing about, no matter what your financial goals might be.
Investing is usually a long-term play
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Definitions vary, but investing is most commonly thought of as an attempt to profit on transactions, stocks, or assets. Often, there is a “safety first” approach, as the most conservative-minded investors will trade off potentially higher returns in exchange for the reduced risk of losing their principle. Safe investments can include bonds, buying property, loans to low-risk borrowers, or investing in blue-chip stocks.
To ensure the highest margin of safety, investors evaluate different assets, industries, and market trends, and try to pick an investment that best is their chance of bringing back consistent returns. The most conservative investor will avoid short-term market volatility by investing in assets or stocks over the long-term, often carried out over many decades, in what’s known as “passive” investing.
This strategy has performed well (think Warren Buffett), particularly with investments in the stock market, as it’s had a historical return of roughly 11% per year, on average. The “average” part is important, because the longer the money is invested, the more it will compound, making it less susceptible to short-term, double-digit dips in the market.
Speculation is usually focused on short-term gains
The old adage “with great risk comes great reward” applies to speculation, which is the act of putting money into investments that have a higher probability of failure, while also sometimes paying off with a big reward. Speculators (which include momentum traders) tend to trade more frequently, and they’ll wager on higher-risk markets such as commodities, cryptocurrencies, or in shares of small or distressed companies.
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Just because speculation carries a higher risk doesn’t mean it’s all gambling, however. The same level of scrutiny and research that’s applied in finding opportunities for long-term investments can be applied to short term cycles and market behavior (you can argue that the short squeeze of Gamestop was rational investing, for example). However, when you have people making these trades based on zero knowledge of what they’re investing in (like crypto, oftentimes), well then, yeah—it’s basically gambling.
Risk is a spectrum that includes both investing and speculation
To know whether you’re investing or speculating, it’s not about what you buy, but why you buy—and that varies for people based on their financial goals. For example, a low-income earner near retirement probably doesn’t want to cash out their 401(k) nest egg to chase a short-term upswing in AMC’s stock. In contrast, someone with more wealth might want to reduce their exposure to just stocks or bonds, so they might be happy investing a small portion of that wealth in high-risk intangible assets like crypto.
While knowing the difference between low-risk and high-risk investments is important, knowing your own risk tolerance matters more (more on that here). And since so much depends on your age, financial status, and retirement goals, consider consulting with a financial advisor to walk you through the trade-offs that come with investing and speculating.