In the last 12 months, the world has welcomed a huge group of people now interested in investing.
And that’s an unbelievably good thing. I love that more folks are now keen to get their money working for them, thinking about wealth and even financial independence.
But I have one concern. There seems to be an increasingly blurred line between investing and speculating. The water is getting muddier and murkier, and nobody seems to care.
Otherwise sensible people are having trouble deciphering what investing really means. There’s a clear case of FOMO out there, and “if you can’t beat ’em, join ’em.”
So it’s time to draw a line in the sand. In this article, I’ll break down what I see as the key differences between investing and speculating.
Quick thoughts before we begin…
I recently shared my disinterest in cryptocurrency as an investment.
Not because I don’t think people will use bitcoin in the future, or that blockchain technology isn’t useful. That’s a different conversation. Instead, I have a fundamentally different view of what investing is.
And to be clear, while I will share examples, this article is not about any single asset, currency, or group of stocks. It’s about how to think and act like an investor.
Also, I have no problem with speculation itself. Just like I have no problem with betting or casinos. What I do have an issue with is pure speculation being considered the same thing as investing.
If you follow the investing world, it’s become clear that we’re in a pretty strange environment right now. Speculation is running rampant.
People are making (and losing) a fortune day-trading stocks. Side note: If I have to watch one more eToro ad on YouTube about “how to safely trade stocks during market volatility” I may lose my shit.
The gains are coming in thick and fast, in crypto, meme stocks (which are usually dying companies), and even newer ‘assets’ like digital art and NBA clips. No I’m not joking.
In fact, this article has taken longer than planned because things are getting crazier by the day. I can’t keep up with the shenanigans. The below examples will explain why.
A sign of the times…
You can now own NBA highlights and trade them in an online marketplace, using blockchain technology. This is a brilliant move by the NBA at monetising its content.
You could, of course, watch these highlights on YouTube. But why do that, when you can buy it and potentially make money? No, not from royalties, but from selling it in the future to someone else for more than you paid.
Clips in the online marketplace are skyrocketing in price. In early January, a LeBron highlight was selling for a few thousand bucks. A little nuts in itself. But by late January, it sold again for over $70,000. And by late Feb, it changed hands for $208,000. Watch it below.
Now, I love a LeBron highlight as much as the next guy. You could watch that dunk all day. But come on! This is why we have YouTube. Free, amazing content whenever we want.
Oh, I forgot to mention, there’s very limited supply of these clips. This obviously creates scarcity and FOMO, the magic ingredient driving the price up. People can’t get enough of these ‘limited edition’ digital card packs.
Let’s recap. The power of the internet makes everything free and accessible. Zero scarcity. But the same power has led to a market where we can ‘own’ clips and trade them. We now manufacture scarcity where none exists.
If I own this clip, do I get royalties? Nope. Does it stop other people from watching? Clearly, no.
Now, I get there are reasons why you might want to own a collectible digital clip. But there is a ton of speculation going on here – with this, and a bunch of other stuff. I enjoyed Josh Brown’s take on the current environment, which you can read here and here.
The whole thing is fascinating, yet very puzzling. NBA clips are nothing compared to the multi-million dollar price tag for this ten second clip of art…
Are you confused yet?
People are excited by the idea of ‘owning’ something you can consume at any time, completely for free. Hmm, I wonder if anyone would like to own and trade Strong Money content on the blockchain? Ha!
More insane examples in this Yahoo Finance article, like the Twitter CEO ‘selling’ his first ever tweet for millions of dollars. And this article by the New York Times on people paying money to ‘vote’ on what their favourite creators and influencers will do, wear and eat that day.
Oh, and a couple of YouTube dudes are selling pictures of their feet in a live auction (with the ownership of these fantastic images secured using blockchain technology, of course).
If all you can think of right now is four letter words, you’re not alone. But wait, there’s more…
Welcome to CryptoPunks…
What is a CryptoPunk? (from the website)
“The CryptoPunks are 24×24 pixel art images, generated algorithmically. Most are punky-looking guys and girls, but there are a few rarer types mixed in: Apes, Zombies and even the odd Alien. Every punk has their own profile page that shows their attributes as well as their ownership/for-sale status.”
So we can buy and sell pixelated images that come with the magical security and transparency of the blockchain. And there is serious money buying these things…
Yes, you’re reading that right. The most popular characters are fetching seven-figures. Number 11 does have a cool hat though. Maybe if the price dips…
In all seriousness, I can’t look at the page for more than about 7 seconds before bursting into laughter.
Be sure to read the “What exactly is going on here?” section to clear up any confusion. It didn’t for me, but maybe you’ll get it.
Then there’s Dogecoin…
A cryptocurrency that was literally made as a joke has a ‘value’ of nearly $10 billion.
Oh and with this one, supply is unlimited. So, um, yeah. It has value because… people think it has value. ¯\_(ツ)_/¯
Are you seeing the bullshit circular arguments and feedback loops at play here?
Man, this thing is a doozy. Even the Dogecoin Reddit page says “to the moon” in the backdrop. It only takes a few minutes at most to see this is another strategy of hype and hope.
But you know what? Maybe I’ve got it wrong. Maybe this is the way forward. In fact, let’s roll with it – I just got an idea.
The #1 digital currency for the FIRE community to reach and sustain their financial independence.
Of course, we’ll have to limit these digital coins to create a nice, pretend amount of scarcity.
There’s already enough of us with a long-term never-sell mindset. If we drum up enough interest from outsiders, we’ll see our coins increase in price relentlessly.
With enough belief that FIREcoin is a good way to invest and transact, there’s absolutely no reason to think this wouldn’t work.
Imagine how many more early retirees we could create! And quickly too. We almost have a moral obligation to do it! 😉
Instead of investing for 10 or 15 years, we’d probably be FI within just a year or two. Now that’s more like it!
Why invest in boring old index funds when you can just buy some FIREcoin?
Be sure to get in touch if you’re keen to get this off the ground. FIREcoin is the future!
Meanwhile, back on Earth
The underlying assumption with the above concepts is that the fanatics believe they are a necessary and valuable step forward in technology. Some of it may be, but I’m not so sure.
Trading pixelated images that look like a bad 1980s video game, recently invented currencies, and 10 second sports highlights back and forth with each other, doesn’t strike me as a valuable use of billions of dollars and millions of hours of human effort and energy.
Anyway! Now that we’ve covered some of what’s going on, let’s get to the heart of this article: the difference between investing vs speculating.
We have to draw the line somewhere. But first we have to know where the line is. So here’s how I separate these two approaches, and why I like certain assets while having zero interest in others.
What is Investing?
In my mind, investing is buying an asset you can own long term and benefit from what the asset produces. Meaning the earnings, dividends, or rent from that investment.
Investing is when your long term returns are driven by one thing: the amount of cash that asset produces over its lifetime.
This is the primary reason investments have any fundamental value at all.
I’m not for one second saying that nothing else is valuable. Plenty of assets have value based on their usefulness or as a consumption good. Whether we need it, or simply enjoy owning it.
Homes, cars, collectibles, commodities, and so on. And while you can make money owning these things, it doesn’t mean buying these assets is investing.
What is Speculating?
In my mind, speculating is buying an asset where your benefit (short or long term) is driven by the price and popularly of that asset.
It doesn’t have earnings, pay dividends or produce rental income. Your return is solely driven by someone else paying a higher price than you did.
Speculating is buying something in anticipation that it will go up in price, because it’ll be more widely used or more popular in the future. The asset itself produces nothing.
And this may well occur. But as a strategy, it is speculating, not investing.
Take cash, for example. You can own cash. It’s valuable and useful. But you don’t invest in cash. Currency is not an investment, whether it’s digital or not. It doesn’t do or produce anything.
Switching your Aussie dollars for US dollars is not investing. You just swapped one currency for another.
Maybe the US dollar rises and then you convert your money back to Aussie dollars, and end up with more money. You made a profit, but you weren’t investing.
Okay, I can hear the arguments…
“But shares and property also rely on prices, so they’re speculative too. Ha!”
Sure, there is an element of price growth in your return in property and shares. But this is a side effect. The reason shares and property increase in value, is because they produce more cashflow over time.
If shares never increase in price, companies will still be making money and, as time goes on, pay higher dividends. As dividends rise and prices stay the same, shares will have a higher yield, creating a higher return even if prices never move.
In the real world, that wouldn’t happen. Investors would start buying to take advantage of the higher returns on offer, and push up prices.
“All assets rely on the future, so it’s all speculation”
Sure, everything is reliant on the future to some extent. But we’re either buying assets with current fundamentals – it has revenue, earnings, dividends, rental income right now – or we’re not.
Regardless of the future, there’s an inherent reason the assets with fundamentals have value right now. Besides, history would probably suggest that it’s more speculative to bet against companies being more profitable in 50 years time.
“But some companies pay no dividends or aren’t even profitable, so their returns come from price growth only”
True. But there is still a business with revenue and employees and small profits in many cases. You own a piece of that company’s earnings from now until forever.
And that’s where the value lies – the long term cash generating potential – whether it pays a dividend right now or not. Assets which are speculative produce zero earnings and never will.
“Well, property investing is speculative since it’s mostly betting on prices”
That’s partly true. But remember, the asset itself is still a proper investment. It will produce a stream of cashflow as long as the person owns it.
Sure, it may not in the short-term depending on how much debt the investor has, but it’s a productive asset nonetheless.
“If you can buy something and it goes up, then that’s an investment”
No, this is nonsense.
My Hyundai i30 is worth more than when we bought in 2019 due to the shortage of used cars around. That doesn’t make it an investment.
“But you can make a non-productive asset produce income”
In some cases you can earn income from speculative assets. Renting out collectible cars, or lending your crypto to earn interest are two examples.
In a sense, it’s technically possible to approach these assets with an investor mindset. But for the most part, this is not the norm and not the reason these assets are bought in the first place.
Besides, the long term success of the underlying asset is still driven by its popularity rather than what it produces.
Why do people speculate?
People speculate because the idea of making fast money is extremely seductive, almost brainwashing in its power.
But there’s also another driver: the belief that you can never be wealthy unless you strike it big. So there’s an element of ‘get rich or die trying’ to all this.
Aside from that, some folks simply hate the thought of long term investing. For three reasons…
— They are impatient and want to be rich NOW.
— They think long term investing is stupid and it doesn’t work.
— They’re thrill seekers, and prefer more ‘fun’ places to put their money.
Speculating is a form of entertainment for some people, which is fine – I get that. But for the rest of us, we need to absorb the difference between investing and pure speculation.
Here’s the problem with speculating
It works until it doesn’t. The more that people jump into the same investment, banking on future price growth, the higher the price goes. This works for as long as enough people keep believing in it. There’s no limit on how long or how high a speculative frenzy can go.
If you get it right, you’ll think you’re smart and double down. If you think you’re wrong, you may think that ‘investing’ is rigged, markets are too risky, or you just got unlucky.
It’s not a reliable and repeatable strategy. The truth is, most stocks underperform the market. And most speculative assets deliver poor long term returns. To sustain high returns means finding new speculative bets to put cash into.
Higher risk strategies are harder, more time-consuming, and stressful. You want your money to work for you, not the other way round. A speculative strategy often means trying to hit home runs. That often results in huge holdings of one or two things, dealing with massive losses from time to time, and spending countless hours thinking about your ‘bets’.
Speculating, bubbles and investing for FI
Each bubble throughout history has a number of things in common…
— Mania, excitement and cult-like behaviour.
— Extreme levels of price growth in a short amount of time.
— Expectations of permanently high returns, and belief that some assets are bulletproof.
— Focusing solely on price growth (income is ignored)
— ‘Investing’ based on short-term forecasts and opinions.
— People day-trading and everything going up in price.
Actually, that’s one good way to test whether you’re approaching things as an investor or a speculator. Hopefully you approach your investing opposite to the above!
But if you are putting a little aside for some speculative ‘fun’, just use a small amount you can afford to lose. I don’t do it, but I understand why some do.
Remember, you don’t need to achieve insane or even high returns to reach financial independence. You simply need to save a good portion of your pay and invest in some low cost diversified investments. Most of your progress will come from saving rather than investing.
“You just don’t understand”
You’re right – I don’t get it. The things I’m seeing just don’t make sense to me. This is pure mania.
Some of the technology I’ve mentioned may turn out to be very useful. And if that’s the case, I’m sure companies all over the world will figure out a way to harness any benefits they can.
But getting all excited about rising prices and jumping in on the action because everyone else is doing it is the opposite of investing. People can multiply their money every month, for a while. But it doesn’t last forever.
The point is not that every single thing is worth nothing. I’m sure some will retain value well into the future. My point is that putting your money into this stuff is not investing.
If you have different definitions, that’s cool. You can follow your own approach, but this is my blog, so I make the rules around here.
What’s the takeaway?
Investing has become seemingly confusing for people in the last few years. So let’s purify the muddy water…
If you’re buying an asset which produces no income, simply in the hopes that it will go up in price, you’re playing the popularity game – speculating.
If you’re buying an asset based on its fundamentals – the earnings or income it produces now and into the future – you’re investing. So, own something even if you could never sell it. Assets like real estate and dividend-paying shares.
Because the less you can care about what markets do, the more powerful and stress-free your position is. Let’s keep this in mind before we go speculating with our financial futures and think it’s investing.