investment vs speculation

I often feel that, on the topic of personal finance, we struggle to communicate effectively because we are not all using the same definition of “investment”.

I think I know why. I want to outline a distinction that I make between investment and speculation. I will provide definitions here which might be slightly unconventional.

investment

Investment means to store value. It usually refers to the purchase of capital (or land) with the expectation that it will roughly keep its value or see a slight increase. It often does result in an increase in wealth, but that is only a goal in the long term.

This is useful because most fiat currencies are inflationary. None of the world’s major reserve currencies¹ are a good store of wealth because they gradually lose value over time. In fact, governments devalue their currency intentionally to discourage holding it. A typical inflation target for monetary policy is a 2% decrease in value per year.

Importantly, investing is not (primarily) a competition. Most investments of this type are win/win or positive-sum: the size of the metaphorical pie is increasing. Every participant can be a winner.

If you have savings in cash, it’s usually to your advantage to invest it in some other asset.

speculation

Speculation is the attempt to turn a profit in the short term by exploiting fluctuations in the prices of goods. Speculators often check the values of their assets frequently — sometimes daily or even multiple times each day. They hope to eke out a bit of cash by opportunistically trading: a local price minimum here, a local maximum there.

Assets ripe for speculation can be zero-sum (or even negative-sum) although it is also possible to speculate on positive-sum assets.

In contrast with investment, speculators are inherently competing with each other. Each dollar that you win by “buying low, selling high” is a dollar that some other speculator has lost. Necessarily, some speculators are losers.

This implies that speculation is effectively a form of gambling.

Most people believe that they are smarter than the average person — and maybe you are! But are you a better speculator than the average speculator? If you are just starting out, then you are competing against opponents with more experience than you.

If it tickles you to follow charts and take risks, you might enjoy financial speculation as a hobby. But unless you are really good at it, you probably should not count on bitcoin for your retirement.