What Is the Difference Between Speculation and Conservative Investing?

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The Merriam Webster Dictionary (online) defines speculation as the “assumption of unusual business risk in the hopes of obtaining commensurate gain.” Speculative investing is the purchase of high-risk assets based on price fluctuations and emotion rather than solid fundamentals. It’s often compared to gambling.

It defines gambling as “the practice or activity of betting: the practice of risking money or other stakes in a game or bet.”

And it defines investing as committing money “in order to earn a financial return.”

Before we delve into the differences and similarities between these terms, let’s take another look at investing, modified by the adjective conservative. Conservative investing is a strategy that prioritizes the preservation of capital over growth or market returns. It is suitable for risk-averse investors who want their money to grow but are afraid of losing their principal investment. Conservative investing seeks to protect an investment portfolio’s value by investing in lower-risk securities such as blue-chip stocks, fixed-income securities, the money market, and cash or cash equivalents.

My brother Mark is a 67-year-old pastor in a small church in Tennessee. He reached out to me asking how best to invest his life savings. Given his age he wanted to protect his principal, even if that meant a somewhat lower return. The investment advisor I spoke with understood this, but ended up selecting both short-term and long-term bonds, along with money market funds. It turned out that the long-term bonds were anything but conservative and lost significant value as interest rates rose from artificially low levels the Federal Reserve had set, to levels much higher and closer to market rates. Higher yields mean lower market value of the bonds.

The main difference between speculating and investing is the amount of risk involved. Investors try to generate a satisfactory return on their capital by taking on an average or below-average level of risk. Speculators seek abnormally high returns from bets that can go one way or the other. The analysis comes down to expected return versus risk. Risk—or the probability of a loss—can be measured using statistical methods that are historical predictors of investment risk and volatility. While we can’t go into the math and statistics in this short article, feel free to investigate these methods in greater detail online:

• The Sharpe ratio measures investment performance by considering associated risks.
• Beta measures the systematic risk of an individual security or sector relative to the entire stock market.
• Value at Risk is a statistical measurement used to assess the level of risk associated with a company. The VaR measures the maximum potential loss with a degree of confidence for a specified period.
• R-Squared is a statistical measure that represents the percentage of a fund portfolio or a security’s movements that can be explained by movements in a benchmark index. In the case of fixed income, the benchmark is the U.S. Treasury Bill.

If you’re not mathematically and statistically inclined, you can simply look at potential investments, along with other similar or like investments, and see how steady or volatile their market price was over a historical period, maybe the last year or two.

The key differentiating factor is RISK. The measurement however can be challenging. Let’s look at a list of seemingly conservative investments and compare them to a list of speculative investment choices carrying far more risk:

Conservative Investments:

U.S. government bonds: Government bonds are considered risk-free. The U.S. Department of Treasury guarantees government bonds. If the U.S. government is good for its debts, interest and principal will be repaid. Consequently, yields are low, today ranging from about 4.5 to 5.5 percent.

Investment grade corporate bonds: Corporate bonds are issued by large companies. Investment-grade are bonds from larger companies with excellent credit and therefore a low risk of default. Ratings of BBB (in the S&P 500) or better are considered investment grade. Bonds with lower ratings are riskier and referred to as “junk bonds.” These may pay higher interest rates, but also have the risk of a higher likelihood of default.

Cash and cash equivalents: Putting your money in a savings account, certificate of deposit, or money market savings account is once again an attractive option. While inflation is running about 3 percent lately, these pay upwards of 5 percent and higher.

Speculative Investments:

Cryptocurrency: Cryptocurrency investments are speculative because crypto lacks fundamentals. Unfortunately, the risk is incalculable. Bitcoin could hit $100,000 this year or $1,000, and there’s virtually no way to know its price direction or magnitude of the price change.

MEME stocks: While you can make money with meme stocks, these are extremely risky. Meme stock investing relies on timing the market, and research has shown that most people don’t possess that gift. Here are some meme stock examples:

• GameStop (GME)
• Coinbase Global (COIN)
• AMC Entertainment (AMC)
• Tesla (TSLA)
• Nvidia (NVDA)

Finally, I leave you with a visual representation of the three primary areas covered in this article. Note the overlap. A conservative investment today can become speculation tomorrow if popularity and momentum take the price beyond any reasonable or defensible valuation.

(Courtesy of Rood Mann. Investing Speculating Gaming.)

Each person must assess their own level of risk aversion, from very conservative all the way to the riverboat gamblers who like to say You Only Live Once (YOLO). The most important underlying takeaway I hope you get from all this is that you must do your best to estimate the amount of risk versus the potential reward or return. Follow me on www.linkedin.com/in/roddyrmann.

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