This article was published on May 28, 2017

The difference between investing and speculating


The difference between investing and speculating

With Bitcoin cracking $2,500 per coin recently, it seems everyone has an opinion on what the future of the cryptocurrency is and whether it is a worthwhile investment.  The hard truth though is that no one with an opinion on bitcoin is making an informed decision.  Rather they are all speculating, not investing.

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While there can never be an investment free of any speculation (nothing is guaranteed and has perfect information), recently society has blurred the lines of what qualifies as an investment.  An investment is based on information that justifies either an increase or decrease in value, whereas speculation is based merely on instinct, even if it believes it has information backing it.

Horseracing is a common speculation since betters believe they can tell “good horses” from “bad horses” and in turn are making informed decisions.  In reality, they have no idea what is going on in the horse’s mind and cannot predict the outcome of any given race.  Conversely strong investments are able to look at assets and prove beyond a certain level of doubt that a given valuation is justified.

The fallacy of Bitcoin

Bitcoin is notorious for its astounding runs in prices.  When the currency first had a major breakout back in 2013 the price moved from just under $200 to over $1,000 in less than a month and dropped back down to $500 in less than two weeks.  Recently, it has surged from under $1,000 to over $2,500 in about 7 weeks.

The biggest problem with Bitcoin is that nothing justifies its value.  Unlike with stocks where you actually own a piece of a company that generates revenue, Bitcoin does not exist.  There is not money backing it and it can be erased, as happened in 2014 when the major bitcoin exchange at the time was hacked.

Betting on Bitcoin is similar to betting on the roll of a dice.  Past rolls have no influence on future outcomes, so realistically at any point the floor could drop out or the price could spike and both scenarios would make perfect sense.  Irrational exuberance, where the mind makes you believe trends are present, is more likely to push the prices up and down than any justifiable value.  However, this means a small waiver in price could result in a massive crash.

Party like its 2008

One of the most common phrases people use when they refer to real estate, is that “real estate is always a good investment.”  Yet if you actually examine the data, the average house price appreciation in the United States is about 0% per year.  Even more so, whatever price appreciation does happen is about 90% correlated to the land value and not the home itself.

With this information, can you actually justify buying houses or even land to sit on, while you wait for increases in value?  If you are doing real estate “speculation” you are flipping a coin to see if you are one of the lucky who does above average.  However, too many people do not understand this is what they are doing when they sink thousands or millions of dollars into these “investment properties.”

This type of irrational behavior is what caused the 2008 housing crisis.  People across the nation truly believed house prices would always increase and were continuing to build and buy homes without taking the time to analyze the data.  Of course, hindsight is always 20/20, but if people are to be intelligent investors and minimize risk, while maximizing returns, they ought to take more time to base decisions on data rather than gut instinct and speculation.

Where is the line?

Unfortunately, there is not an entirely clear distinction between speculation and investing.  Who could have predicted the rise of Facebook back when Mark Zuckerberg first founded it back in his Harvard days?  Who could have seen Apple rebound, overtake Microsoft, and become the most valuable corporation on Earth?  In even the best researched investments, there is a certain level of analysis for market trends that cannot rest on computation.

Tesla Motors has recently cracked the $300/share price point and become the most valuable American car company.  Yet, when you drive around, how often do you see a Tesla on the road?  If you talk to the top Wall Street analysts, you will have starkly split opinions on whether Tesla is under or over-valued.

Credit: Web Summit / Flickr
Dublin, Wednesday 31th October 2013: Pictured at the The Web Summit 2013, RDS. Photo by Dan Taylor/Heisenberg Media

Those who subscribe more to tech will say that Elon Musk is one of the most brilliant minds of our time and has proven he is able to achieve the impossible.  They will note the brand value of Tesla, its investment in a powerful infrastructure, its driverless car technology, and the percentage of cars that will be electric in the future.  All of these metrics have clear value, but tell a different story than what is presently occurring.

Analysts who are more focused on automotives and manufacturing will talk about the lack of sales, struggles of car supply chains, problems on incoming competitors, and high price point of Teslas.  These individuals are certain Tesla’s $300+ price per share is a drastic overvaluation and caused by irrational exuberance, but those in favor of Tesla will say this is just the beginning and Elon’s vision and investment in the future of the company will lead to an increase in value.

Just as with Bitcoin, only time will tell which camp is correct, but the difference is that each analyst has a base of data backing their beliefs.  If you struggle to identify what the value of the investment is or use vague trends and personal beliefs to justify the action, then you are likely speculating rather than investing.

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