Are you an investor or a speculator?

If „an investor could be defined as someone who forgives a right to consume now with an aim to gain a financial return in the future“, very little would seem to distinguish between speculative activities and investing endeavours.

In most cases, we believe few people make the distinction. Many investors enter into speculations when they make a bet on the direction of currencies or oil prices. Many speculators see themselves as investors when buying stocks of fundamentals ahead of the next quarterly earnings. Even the most value oriented hedge funds speculate, simply because leverage and their short selling activities.

And yet, we believe understanding the difference between the two is as critical understanding the difference between price and value. Warren Buffet summarises perfectly: „Price is what you pay, value is what you get“. 

Clearly, this distinction should alert on the fact that if the goals of achieving the best annualised return on capital over time is the same, the focus, the means and the discipline to achieve this goal would differ considerably. Deciding whether to act as an investor or a speculator should define everything else.

This post makes no judgement on which approach is best. We believe each person must strive to adopt an approach that best fits his or her personality and financial conditions. We are value investors at heart. However, we do not renege on speculations when these make sense.

Both investors and speculators serve a clear economic purpose: investors provide capital and speculators provide market liquidity. Both are essential actors of the price discovery mechanism and should be seen as the two sides of the same coin.

If one thing define a speculator, it is its primary focus on price. He or she “would know the price of everything and the value of nothing”. His or her aim would be to buy low and sell high or sell high and buy low with a view to generate a profit. For the speculator, price and time are the ultimate facts and timing is everything.

In that sense, it could be argued that the vast majority of market participants are speculators. By providing liquidity speculators facilitate exchanges and lower transaction costs. In turn, lower transaction costs and liquidity tend to attract speculators, hence a clear tendency by speculators to focus on trends and momentum.Speculators also  operate within shorter-term horizons, such that price volatility would be a material consideration. Since prices follow the law of supply and demand, a speculator would focus on determining the direction and the power of these two forces.

An investor cares about prices only to the extent that low prices provide an entry point to buy assets at or below their true worth. Valuing an asset is relatively numerical and based on utilitarian criteria. It can mean different things to different people, including the reconstruction costs of the assets, earnings power (income/yield) and a growth opportunity.“Quantify, quantify, quantify” and a „margin of safety“ are the investor’s four basic tenets.

Investors base their decisions on the facts underpinning the value of their investment, not on price fluctuations. As Buffet (him again) puts it; „use the market to serve you, not to instruct you“. This means that an investor should be ready to accept (even welcome) temporary price fluctuations. Volatility is risk for speculators, but an opportunity for investors.For an investor lower prices are good news, for the primary aim of an investor is capital preservation (risk reduction/margin of safety), increasing yield and increasing the odds of capital gains.

An investor would tend to buy for the long run and focus on maximising margins and minimising tax with a low risk/low asset turn strategy. 

A speculator on the other hand, will be attracted by the prospect of quick profits (with a propensity to turn its asset often, i.e. high asset turnover), by low transaction costs and the possibility of leverage.

An investor want safety of capital (or the return of his capital), income, capital appreciation if possible. As a result, investors would tend to focus on yielding assets (stocks and bonds), while speculators would have a preference for non yielding assets such as currencies and commodities.

For an investor, the prime focus should be on value first, price second. For a speculator, the main focus is price first and second. 

The investor has two major competitive edges versus the speculator: he or she can rely on income and uses time as his friend not his enemy. 

An investor should consequently view his or her speculations as limited in time and his or her investments as his or her future. However, an investor who overtrades is condemning him/herself to mediocrity. Similarly, a speculator who does not cut his or her losses quickly or average down his position on any other considerations than its price stops is likely to be a destined loser.

In conclusion, the key to investing and speculating is to know who you are and stay true to it. Know thyself and plan accordingly should be the first rule of engagement.

Are you an Investor or a Speculator?

	Investor	Speculator
Asset classes of predilection	Bonds Stocks	FX Commodities
Focus	Value	Price
Time horizon	LT	ST
Asset turn	Low	High
Margin	High	Low
Leverage	Low	High
Bias	Contrarian	Trend follower
Strength	Analytical	Execution
Brain	Left / Thinking	Right / Acting
Appetite	Income	Capital
Risk appetite	Low	High
Key concept	Margin of safety	Timing is everything
Likes	Quality	Quantity
Analytical tendency	Bottom up	Top down
Buys when	Undervalued & margin of safety	Price rising & visible trend
Virtue	Research/ Patience	Speed/Reactivity

Source: 4SOI