Speculation vs Investing

Background

In this dynamic era, major shifts occur in financial markets as time progresses. New financial vehicles emerge with promises of high returns, sometimes seeming to be too good to be true. In navigating this arena there are different schools of thought when it comes to investing, which may appeal to different persons while speculation is a totally different animal. Let’s examine the dynamics.

Investment like martial arts

Successful investing requires effort, patience, discipline, a reliable theoretical framework or philosophy and knowledge of self. Investing, like martial arts, involves an integration between knowledge of self and the asset at hand which creates harmony, in turn producing consistent returns over time. The more skilled one becomes in investing the less hits one takes and the more hits one makes.

Importantly, regardless of however skilled one may be, there will be days when we all take hits. Investing, like martial arts, is a journey which urges the practitioner to understand that there is always something to learn and that another level can be attained, even as a master. Different martial arts may suit different persons so a particular investment approach may not be for everybody. However, what is common between all these martial arts are the concepts of wisdom, self control, the pursuit of knowledge and a set of mental guidelines that opens the door for progress over time. Finally, martial arts begins in the mind and not with material possession and is meant for productive and not destructive purposes.

Speculation

In most scenarios speculation primarily relies on market momentum to drive the face value or price of a financial asset in lieu of the ‘value creation process’. This market momentum is usually driven primarily by raw emotion. Separately, it’s imperative to note that every asset is in some way backed by the ‘value creation process’. The ‘value creation process’ is simply the creation of value driven by putting an asset to productive work.

For instance, shares in an ice cream company that produces $3.0M in net profit will increase in value when it produces $3.8M in net profit in the following year. However, speculation is illustrated when the share price of the ice cream company goes from $5 to $14 in a over time without any positive change in financial results, ie the value creation process.

Another example is if the price of a currency swells without a corresponding increase in commercial transactions in said currency, then we can observe speculation here. The wider the gap between the price increase and the value creation process, is the higher the level of speculation. This gap is commonly referred to as a bubble, often driven by raw emotion. Bubbles are frequently destructive and cause serious financial displacement which results in stagnation in the aftermath. This is linked to the fact that raw emotions are temporary and change sharply within a small time window, resulting in volatility. This is in contrast to investing because of the over exuberance, unjustified aggression and impatience involved.

Overview

In this day and age we must all remain vigilant as rapid technological advancement transforms the industrial economy into a brand new machine. A machine which we are all getting to know as it is getting to know us. Investing and speculation have been at war since the dawn of trade and we must understand the difference between them if we are to successfully meet our financial goals and provide the life that we want to live in a sustainable way.

By Julian Morrison

Julian is an Investment Advisor at the JMMB Group with experience in Insurance, Banking and Economics. He holds a Wealth Management and Financial planning certificate and another in Mergers and Acquisitions from the Jamaica Stock Exchange. Julian is also a member of the Jamaica Chamber of Commerce and takes a special interest in the development of Micro, Small and Medium Sized Enterprises (MSMEs) in the Caribbean.