Investment Commentary Robert G. Hagstrom, CFA What is the Difference Between Chief Investment Officer Senior Portfolio Manager Investing and Speculation? February 18, 2021 Reddit, WallStreetBets, Robinhood, short selling and short squeezes, cryptocurrency, and special purpose acquisition companies (SPAC) have all lit up recent financial headlines. Rock stars and rappers are tweeting their best stock ideas to millions of traders. If you are going to win, “you have to be willing to lose it all” (1) has become the rally call for the “messiahs of momentum.” (2) One might be correct to think the stock market has lost its mind. However, this is not the finale but a recurring play on speculation that has periodically invaded markets since the first shares of common stock were traded on the Amsterdam Stock Exchange in 1602. And what unites these many speculative episodes throughout history has not so much been the reckless behavior of investors, but how the hyperactivity of wanting to make the most money in the shortest period of time can suck the oxygen out of the stock market for long-term investing. As mentioned, the tug-of-war between investing and speculation is nothing new. However, the persistent confusion over the difference is a mental mistake—some would say a chronic disease—that, too often, can become fatal for many investors. Benjamin Graham, the dean of security analysis, rightly warned that the greatest danger investors face is not so much speculation, but acquiring speculative habits without realizing they have done so. And in doing such, investors can end up with a speculator’s return by believing that they were investing. That individuals have not learned the difference between investing and speculation is arguably one of the most important unlearned lessons that still haunts investors. And the fact that there is still confusion is cause for concern—particularly during the current financial times. For this reason, we believe it is important to share with you the following commentary, “What is the Difference Between Investing and Speculation?” written in February 2013 for the CFA Institute’s Enterprising Investor. This commentary, written eight years ago, speaks to the ongoing challenge of distinguishing the differences between investing and speculation. As evidence, Enterprising Investor re-published the commentary this month, showing that now more than ever, it is critically important for investors to understand what is investing and what is speculation. CFA Institute Enterprising Investor February 2013 What is the Difference Between Investing and Speculation? By Robert G. Hagstrom, CFA What is the difference between investing and In his famous dialogues, de la Vega observed speculation? At first, the answer seems simple three classes of people. The princes of business— (1) Otani, Akane. “Teens because the distinction is obvious — that is, until called “financial lords,”—were the wealthy and Gambling Their you actually try to answer the question. investors. The merchants—occasional Savings on GameStop speculators— were the second class. The last Stock: Their Parents are Go ahead. Take a few seconds and think about it. class was called the “persistent speculators” or Worried.” The Wall Street Write down “investing.” Now write the definition. the “gamblers.” Journal. February 16, Do the same for “speculation.” If you are like me, 2021. frustration quickly builds because the answers do Since the Dutch shipping firm Vereenigde Oost-Indische became the first company to trade (2) Zweig, Jason. “How not come quickly or easily, and they should. After its shares on the Amsterdam Stock Exchange, the Stock Market Works all, these terms have been a part of the financial Now: Elon Musk Tweets, investors and speculators have coexisted in the lexicon since Joseph de la Vega wrote Confusion Millions Buy.” The Wall marketplace. Over that 400-year time period, the Street Journal. February of Confusions in 1688—the oldest book ever noteworthy have offered their own definitions of 12, 2021. written on the stock exchange business. investing and speculation, but none have stuck. Investment Commentary Philip Carret, who wrote The Art of Speculation the 20th century, was also a skilled buyer and (1930), believed “motive” was the test to seller of stocks, bonds, commodities, and determine the difference between investment currencies. In addition to thinking about and speculation. “The man who bought United economics, he was intrigued with the stock States Steel at $60 in 1915 in anticipation of market. Tucked inside his magnum opus, The selling at a profit is a speculator…On the other General Theory of Employment, Interest, and hand, the gentleman who bought American Money (1936), is a chapter titled “The State of Telephone at $95 in 1921 to enjoy the dividend Long Term Expectation.” Here, Keynes got right return of better than 8% is an investor.” Carret to the point, deciding to “appropriate the term connected the investor to the economics of the speculation for the activity of forecasting the business and the speculator to price. psychology of the market, and the term “Speculation,” wrote Carret, “may be defined as enterprise (a word he used for investment) for the the purchase or sale of securities or commodities activity of forecasting the prospective yield of in expectation of profiting by fluctuations in their assets over their whole life.” But the breadth of prices.” the chapter has less to do with the difficulty of Benjamin Graham, along with David Dodd, defining investment and speculation and more to attempted a precise definition of investing and do with the observation that the lines between speculation in their seminal work Security the two approaches had blurred. It is the same Analysis (1934). “An investment operation is one point that is driven home 75 years later in The which, upon thorough analysis, promises safety Clash of the Cultures: Investment vs. Speculation of principal and a satisfactory return. Operations (2012). In his book, John Bogle argued that in the not meeting these requirements are speculative.” minds of most individuals, investment and Despite being the “dean of security analysis,” speculation are now indistinguishable. Graham’s definition left readers wanting more — All market activity lies on a time continuum. a fact he confessed years later when he wrote The Moving from left to right, we observe buy and sell Intelligent Investor (1949). “While we have clung decisions in the stock market that occur in tenaciously to this definition,” said Graham, “it is microseconds, minutes, hours, days, weeks, worthwhile noting the radical changes that have months, years, and decades. Although it is occurred in the use of the term ‘investor’ during unclear exactly where the demarcation line is this period.” located, it is generally agreed that activity Graham was concerned that the term “investor” occurring on the left side of the time continuum is was being applied ubiquitously to anyone and more likely to be speculation, whereas activity everyone who participated in the stock market. residing on the right side is thought to be He explained: “The newspaper employed the investing. In Bogle’s opinion, investment means word ‘investor’ in these instances because, in the long-term ownership whereas speculation is easy language of Wall Street, everyone who buys more short-term trading. Carret concurred, or sells a security has become an investor, writing: “The time requisite for the regardless of what he buys, or for what purpose, accomplishment of the adjustment of prices to or at what price, or whether for cash or on values is a factor of great weight to the margin.” Graham went on to say: “Since there is speculator. Here he parts company with the no single definition of investment in general investor, to whom it is of little concern.” acceptance, authorities have the right to define it Thinking long term or short term might be a pretty much as they please. Many of them deny sensible starting point that helps us distinguish that there is any useful or dependable difference between investing and speculation. But a between the concepts of investment and of “stopwatch” definition leaves us woefully short of speculation. We think this skepticism is what is ultimately needed to better understand unnecessary and harmful. It is injurious because it the differences between these two approaches. lends encouragement to the innate leaning of A time element is simply not sufficient. The many people toward the excitement and hazards distinction between investment and speculation of stock market speculation.” is more complex than this. John Maynard Keynes, best known as one of the Let me be clear. This not a sneaky attempt to founders of modern macroeconomics and demonize speculation and declare that only thought to be the most influential economist of investing is sacrosanct. Academic research clearly 2 What is the Difference Between Investing and Speculation? February 2021 Investment Commentary demonstrates that the market benefits the unavoidable.” But Graham was quick to participation of both investors and speculators. distinguish between “good” and “bad” Although some investment purists might vote for speculation. “There is intelligent speculation as opening the stock market just one day each year there is intelligent investing. But there are many and on that day all buyers and sellers would ways in which speculation may be unintelligent,” transact business, the lack of daily liquidity would wrote Graham. likely do more harm than good for the capital But how can we distinguish between what is markets. Furthermore, despite its negative “good speculation” and “bad speculation,” or connotation, it can be argued that some types of “good investment” and “bad investment” for speculation are, in fact, socially redeeming. Lynn that matter, when we don’t even have a firm Stout, Distinguished Professor of Corporate and grasp of the basic definitions? Lacking clearly Business Law at Cornell Law School, in understood boundaries, individuals are “Uncertainty, Dangerous Optimism, and wandering aimlessly back and forth between the Speculation: An Inquiry into Some Limits of worlds of investing and speculation.