The Difference Between Investing and Speculating: Why You Should Avoid Speculation?

The biggest difference between investing and speculating is the nature of returns and the underlying approach to generating those returns.

Li Lu is best known as the fund manager whom the great Charlie Munger himself trusted with his investments. This is shared from the translated notes of Li Lu’s speech, which he gave to his students at a Chinese business school back in 2019...

Nature of Returns:

• Investing: In a sustainably growing economy, investing typically leads to sustainable growth in profits and investment returns over the long term. This means that the returns from investing are expected to increase steadily and reliably as the company and the economy grow.
• Speculating: Speculating, on the other hand, is based on predicting short-term price movements and the behavior of other traders. In the long run, the gains and losses of speculators in the market tend to balance out to zero, because for every gain there is a corresponding loss. This makes speculation a zero-sum game, where long-term sustainable returns are not guaranteed.

Underlying Approach:

• Investing: When you invest, you are typically focusing on the long-term fundamentals of a company, such as its business model, financial health, competitive position, and growth potential. You are betting on the company's ability to generate sustainable profits and growth over time.
• Speculating: Speculating involves attempting to profit from short-term market fluctuations and price changes, often based on market sentiment, technical analysis, or other traders' behaviors. This approach does not necessarily take into account the underlying value or long-term prospects of the company.

And this is largely differential as some speculators whose chances of winning are higher and who can continue winning for longer; equally, there are some who will always be the sucker at the table and never strike it rich. However, given enough time, when you add the winners and losers together, the net result will be zero. The reason is that speculating on short-term behavior in the market adds nothing to the economy or to corporate earnings growth.

Relatively speaking, the speculative part of the market verges on being a casino. From a social welfare point of view, we do not want this casino to be too big. However, without it, the market would not exist. We should, therefore, see speculation as a necessary evil—and a part of human nature—which cannot be removed. We cannot deny the parts of human nature that love to gamble and speculate, but we cannot let them overwhelm us.

Once you understand the principle of a zero-sum game, you will begin to see these speculators as Mr. Market.

In summary, investing is about committing capital to assets that are expected to grow in value and provide returns over the long term, driven by the fundamental performance of the underlying company and the economy. Speculating is about trying to profit from short-term market movements, which involves higher risk and does not inherently lead to sustainable long-term returns.

Understanding this principle helps you navigate the market more wisely and view speculative behaviors in their proper context.

Know more about the examples of the consequences of meeting market momentum as a result of non-data-backed speculation...https://www.dhirubhai.net/feed/update/urn:li:activity:7197910657298509824