There are many other types of investments that I won’t be covering in this course – ones that don’t create value. It’s not that these types of investments are bad, but they’re inherently different.
There’s a term in the investment world called speculation. A speculative investment is one where the buyer is less concerned on the overall value of what they’re investing in, and instead are trying to make money from the market swings. I like this definition from Market Business News:
“He or she is less concerned with the fundamental value of a security, and more on price movements. The investor doesn’t care about the annual income the asset may bring, such as dividends or interest payments. What matters is how much he or she can sell it for at a future date.” – https://marketbusinessnews.com/financial-glossary/speculative-investment/
When I started learning about investing, it seemed like everything was a speculative investment. I bucket things into three distinct categories:
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Savings, investments and speculation.
Side note: I can’t hear speculation without hearing Thomas Jefferson sing the line from Hamilton:
[show screenshot of Jefferson, Burr and Madison approaching Hamilton]
[JEFFERSON] And the evidence suggests you’ve engaged in speculation
[BURR] An immigrant embezzling our government funds
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With savings we have investments that are as safe as we can make them. This includes your checking account, your savings account, maybe a high interest savings account. This could include a CD, a certificate of deposit, which pays a slightly higher return rate.
These have one thing in common – they’re backed by the US government. The only way for them to lose value is due to inflation or the government collapsing.
Next we have investments. An investment is allocating money (it could be time or other resources, but we’ll focus on money) to make more money. Investments typically provide income AND growth. In our stocks and bonds example, they provided dividends (income) and the price of the stock grew (growth).
For me, every single investment I make I do with one idea in mind: do I want to invest in this for the rest of my life. If the answer to that is yes, I consider it an investment.
The last category is speculation, or speculative investments. We’ll classify these as places we’d allocate our resources short-term with an intention of a larger payoff.
The US Commodity Futures Trading Commission defines speculation as:
“A trader who does not hedge, but who trades with the objective of achieving profits through the successful anticipation of price movements.”
In other words, speculation is about getting in at the right time, making a buck and getting out. While investing is about long-term, sustained growth.
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For example, if you bought a painting. It may be beautiful and may grow in value, but its not creating value in and of itself. If you’re buying it to hang on your wall for the rest of your life, that’s an investment. If you’re buying it because you believe it’s going to increase in value and you can sell it for that higher price, that’s speculation.
The same is true for real estate. Real estate is a tremendous way for people to make money – especially through buying and renting for a profit. That’s less an investment and more a business. As a matter of fact, that S&P 500 fund we’ve been using, VFIAX, invests a little over 3% in real estate companies. This is investing in companies though, not investing in individual properties which is something very different.
Another term you might hear people invest in is “commodities”. Commodities are real-world good that actually exist (or an option to buy them). These can be foods like grain or beef, energy like oil or natural gas, or resources like gold or coal. When you invest your money in a commodity, you’re doing so with the hope that it will gain value and you’ll be able to sell it later. While your money is invested in that commodity it won’t make you any money, or provide you any value – unless you’re buying actual gold and get a lot of enjoyment from looking at it.
If you put $100 in gold back in 1980, you’d have about $75 today. That’s a -0.7% a year return over 40 years. There have been periods where if you bought and sold at the right time you’d make money, but there’s no value provided by owning gold. If you put $100 in an S&P index fund in 1980, you’d have about $7,500 – that’s an 11.4% return! The takeaway here is that money in commodities is made by buying and selling at the right time – not by holding long-term.
One type of speculative investment that has gotten a lot of attention lately is bitcoin and other cryptocurrencies. These are absolutely speculation. There are people who say bitcoin is a new paradym that’s going to replace the dollar – but think what they stand to gain by having people use it – they see the price of their speculative investment grow! Bitcoin is the new gold – something given value because people believe it has value. While some people have made a lot of money speculating with Bitcoin and other cryptocurrencies, these are not investments, but speculation.
To me, investing in individual stocks is speculation. I can’t anticipate which stocks I’d want to hold forever, so by that definition all stocks would be speculative. A stock index fund would be an investment, since it adapts and changes based on the markets.
We talked some about bond funds before – but not all bond funds are equal. There is a grading system for bonds where the higher the grade, the more likely they are to pay back their investors. I take these ratings with a grain of salt. During the Housing bubble a bunch of bonds that were rated AAA – the highest rating – collapsed completely. There are bonds that have a much lower rating, going from AAA to AA to A, down to B, C and lower. These lower bonds get into the speculative realm as well.
So how much money should you put into each of these three buckets savings, investments and speculation? This will be determined by your risk tolerance, but the vast majority SHOULD be in investments. You likely don’t need much cash either.
“If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes”
I recommend keeping 3-6 months cash easily accessible in savings while you have a job and are making income. This is to buffer from emergencies and allow you some breathing room. You may want to allocate more if your income is inconsistent, or less if your income is stable and your expenses don’t vary much.
If you don’t have a stable income coming in, then you might want to keep 1-3 years of cash handy. This gives more flexibility to sell of less of your portfolio in years where the market has declined significantly.
On the speculative side, how much you put there is entirely up to you. If you’re just getting started investing, I’d error on the side of caution and put 0% towards this for now. Instead, focus on learning how to invest first. Then after that if you want to up this that would be a good time.
For reference, I allocate about 5% of my portfolio to speculative investing. In this speculative subset of my portfolio I’ve invested in Bitcoin, Apple, Tesla, Southwest and other things. Some I’ve picked the right time to invest in, others not so much. The nice part is that even in the worst case I would only lose 5% of my total portfolio.
The entire rest of your portfolio should go towards long-term investments – one you plan to hold until you need the money. That’s the focus of this course, and the biggest piece of most peoples portfolios.