Question...
- Thread starter shagdrum
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cammerfe
Dedicated LVC Member
In a word, I'd say 'risk'. Or make that 'degree of risk'. If, objectively, you're taking a significant gamble, it's 'speculation'. Otherwise, it's 'investment'.
KS
KS
But "risk" is a arbitrary and individual determination. What is exceedingly risky for one man is not at all risky for another.
If I make $10,000 a year, a $5,000 investment is very risky. But that same investment is of little risk for someone earning $100,000. There are also other factors like knowledge of a market to be invested in (or lack thereof) that differentiate risk in different circumstances.
The reason I have taken an interest in this is that I hear and read a lot of hand wringing about the "evils" of "speculation" without any specific explanation of what "speculation" is. All I hear is moral condemnation, which raises the BS alarm in my mind.
In looking into what, specifically, speculation is, and why it comes about, this is a question that has popped into my head. It seems that "investment" in one man's eyes is "speculation" in another man's eyes. No objective, specific definition or standard of judgment is given.
Shag - someone once explained this to me in fairly concise manner....
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Investment contains a variable of speculation - some investments are more of a 'gamble' than others, or more speculative.
However, speculation is never a form of investment.
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Speculation is a way to quickly make money - you are not 'investing' in a company - not looking at long term gains, but playing a market to make the most money you can in the shortest amount of time. You are making money in fluctuations of the market, rather than making money on the expectations and performance of a specific company or industry, as you do when you invest.
Both are a part of capitalism - they are intertwined at some point. However, speculation is also more easily manipulated, because it is for a shorter time frame. It is harder to manipulate a long term investment rather than a short term speculation.
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Investment contains a variable of speculation - some investments are more of a 'gamble' than others, or more speculative.
However, speculation is never a form of investment.
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Speculation is a way to quickly make money - you are not 'investing' in a company - not looking at long term gains, but playing a market to make the most money you can in the shortest amount of time. You are making money in fluctuations of the market, rather than making money on the expectations and performance of a specific company or industry, as you do when you invest.
Both are a part of capitalism - they are intertwined at some point. However, speculation is also more easily manipulated, because it is for a shorter time frame. It is harder to manipulate a long term investment rather than a short term speculation.
What determines short term vs. long term? Why?
Why is "speculation is never a form of investment"? Every definition or explaination of investment I see would include speculation.
Would a grocery store be "investing" or "speculating" when they buy crates of eggs to resell by the dozen? There is no real industry or company being invested in, only a commodity that would presumably qualify as "short term"?
The more I look at it, the more it is a hard idea to pin down.
There is also the issue of how it came about and what function it serves. This was cited on Wikipedia by Victor Niederhoffer:
Why is "speculation is never a form of investment"? Every definition or explaination of investment I see would include speculation.
Would a grocery store be "investing" or "speculating" when they buy crates of eggs to resell by the dozen? There is no real industry or company being invested in, only a commodity that would presumably qualify as "short term"?
The more I look at it, the more it is a hard idea to pin down.
There is also the issue of how it came about and what function it serves. This was cited on Wikipedia by Victor Niederhoffer:
“Let's consider some of the principles that explain the causes of shortages and surpluses and the role of speculators. When a harvest is too small to satisfy consumption at its normal rate, speculators come in, hoping to profit from the scarcity by buying. Their purchases raise the price, thereby checking consumption so that the smaller supply will last longer. Producers encouraged by the high price further lessen the shortage by growing or importing to reduce the shortage. On the other side, when the price is higher than the speculators think the facts warrant, they sell. This reduces prices, encouraging consumption and exports and helping to reduce the surplus
By this explanation, speculators seem to "lubricate" market adjustments in a way.Just as I said shag -
all investments include some amount of speculation -
The person who is just speculating doesn't care if he is buying soy beans or hog bellies, Apple or Microsoft - he is just playing market fluctuation entirely, for a short term gain. There isn't what is considered a 'traditional' investment there.
As I said it is part of the market, and it isn't 'evil' or anything, it is just a way that commodities (usually) come to market.
What can happen though is because of the 'power' of some people within a segment of the market they can very artificially increase the value of something. So, say you had a fleet of tankers, and the ability to buy a huge amount of oil. You could fill your tankers and sit them offshore - artificially creating a market scarcity. It works especially well if you also own a large amount of the other parts of the oil business - such as refinery capability. You might want to do this to raise the cost of gas right before a busy season - such as summer - or you may have a political motive - to make a political decision appear bad. Both of those could be artificially affected by someone who had enough power/funds.
We need to have speculation - such as your example showed shag - it regulates markets, creates incentives, gets things moving. But, market speculation by the people who control the commodities is a little like insider trading - it really shouldn't be allowed. However, that isn't regulated like insider trading is.
Investment: Property or another possession acquired for future financial return or benefit.
Investment is putting money into something with the expectation of profit. More specifically, investment is the commitment of money or capital to the purchase of financial instruments or other assets so as to gain profitable returns in the form of interest, dividends, or appreciation of the value of the instrument
By any of these standards, speculation seems to be a not so distinct from investment.Investment is putting money into something with the expectation of profit. More specifically, investment is the commitment of money or capital to the purchase of financial instruments or other assets so as to gain profitable returns in the form of interest, dividends, or appreciation of the value of the instrument
Benjamin Graham said, "The difference between investment and speculation is understood in a general way by nearly everyone, but when we try to formulate it precisely, we run into perplexing difficulties. In fact something can be said for the cynic's definition that an investment is a successful speculation and a speculation an unsuccessful investment."
With very vague definitions it is easy for "speculation" to simply become moral condemnation for "investment practices ones doesn't agree with". In order to cut through the rhetoric, a thorough understanding of what speculation is and what function it serves is necessary. It seems that "speculators" are the go-to scapegoat for any and every economic bubble.
Any answer like that always strikes me as too easy and doesn't really to explain anything. How was speculation able to create a bubble in one market but not another? What other factors (if any) facilitated that bubble?
Philip L. Carret provided an interesting definition, "Pure speculation involves buying and selling in the same market without rendering any service in the way of distribution, storage and transportation".
Speculators do provide a value. They often have a knowledge of the markets they are investing in (which is far different then a knowledge of the commodity itself, and in some ways more valuable). That knowledge mixed with the profit motive typically allows them to more efficiently distribute resources; meeting higher demand when it occurs, liquidating excessive supply, etc.
Murray Rothbard said, "the more...[a] speculative, element enters into supply and demand, the more quickly will the market price tend toward equilibrium."
Speculators also assume risk (probably their primary function). While a farmer has a stronger understanding how to grow wheat then a speculator, that speculator typically has a stronger understanding of the wheat market. This means when he agrees to buy the wheat from the farmer at harvest time at a price agreed to beforehand, the risk the farmer would otherwise assume in selling it himself is transferred to the speculator who, due to his knowledge of the market, reduces that risk. The sheer size of the speculators assets may also reduce the risk to them.
The point about speculation, on a large scale, being used to manipulate markets is worth looking into, but it can only get confusing without a strong understanding of what speculation is and is not.
However, on that, it seems we can agree that speculation seems to serve a positive purpose unless and until it gains undue influence in the market (as opposed to simply reacting to and anticipating the market).
As to the gambling analogy, one of my favorite economists, Thomas Sowell, made an interesting point on this in his book, Basic Economics;
Speculation is often misunderstood as being the same as gambling, when in fact it is the opposite of gambling. What gambling involves, whether in games of chance or in actions like playing Russian roulette, is creating a risk that would otherwise not exist, in order to either profit or to exhibit one's skill or lack of fear. What economic speculation involves is coping with an inherent risk in such a way as to minimize it and to leave it to be borne by whoever is best equipped to bear it.
Couldn't go without quoting Sowell. 
Speculation is gambling (more) than investing, think of it as playing Texas Hold'em - there are odds - you are playing the odds. You know some facts - but there are a lot of unknowns. With investments - over time, the investment averages out the hills and valleys of the 'unknowns'.
Shag - I think if you talk to most brokers or investment counselors they will tell you that most of the difference is in 'time'. You can speculate in stocks, real estate, metals, etc., as well as commodities - but it usually means that you hold the asset for a short amount of time. If you 'invest' in gold - you will be holding it for a longer period of time.
So - I am not allowed to speculate - my investment guy knows it would drive me crazy.
Shag - I think if you talk to most brokers or investment counselors they will tell you that most of the difference is in 'time'. You can speculate in stocks, real estate, metals, etc., as well as commodities - but it usually means that you hold the asset for a short amount of time. If you 'invest' in gold - you will be holding it for a longer period of time.
So - I am not allowed to speculate - my investment guy knows it would drive me crazy.
"Time" or "degree of risk" are arbitrary, vague standards of judgment that, unfortunately, allow for a lot of misleading rhetoric.
That difference between gambling and speculation is very significant. Gambling creates risk in order to profit from it. Speculation is a means to minimize risk that naturally occurs in the market.
What is interesting is when that role of speculators is distorted in a market. With regards to the housing market, Fannie and Freddie as well as the strengthened Community Reinvestment Act completely distorted the incentive structure under which speculators functioned while effectively forcing financial institutions to engage in that speculation.
When risk is completely socialized and reward remains privatized, amateur speculation is injected into the market and risk is impossible to estimate (let alone work to minimize). Speculation ceases to serve it's vital market function.
Combine that fact with the Fed tinkering with the interest rate and we get the economic bubble that burst in 2008.
That difference between gambling and speculation is very significant. Gambling creates risk in order to profit from it. Speculation is a means to minimize risk that naturally occurs in the market.
What is interesting is when that role of speculators is distorted in a market. With regards to the housing market, Fannie and Freddie as well as the strengthened Community Reinvestment Act completely distorted the incentive structure under which speculators functioned while effectively forcing financial institutions to engage in that speculation.
When risk is completely socialized and reward remains privatized, amateur speculation is injected into the market and risk is impossible to estimate (let alone work to minimize). Speculation ceases to serve it's vital market function.
Combine that fact with the Fed tinkering with the interest rate and we get the economic bubble that burst in 2008.