Investing vs. Speculating: Understand the difference so that you aren't taking needless and fruitless risks with your financial portfolio
What is investing? An attempt at a definitive definition.
Here's our definition for what investing is:
Investing, in the financial sense of the word, is the deployment of capital (usually money) into the purchase of shares, purchase of assets, development of commercial ventures, or other financial schemes in order to obtain a return on that deployed capital with a reasonable expectation (grounded in some sort of reasonable analysis) that the risk-adjusted or expected return is positive.
That's a long and somewhat fluffy definition, but any definition that would cover the broad range of activities that could properly be classified as investing will be somewhat fluffy. Let's break down the main elements of that definition and discuss them briefly.
...the deployment of capital...
This means you use some sort of capital (usually money) to invest. Without using or committing capital, you're not really investing. You can invest your time and energy into things, but that wouldn't qualify as financial investing. You must deploy capital in some way for your activity to properly be called investing in the financial sense of the word.
...or other financial schemes...
Investing requires the deployment of capital in a specific way. It requires that the capital be used to either purchase shares of a firm (the firm can be publicly traded or privately held), purchase assets (purchasing gold, Bitcoin, fine rugs, or fine art might qualify as asset purchases), develop commercial ventures (start a business or develop a new office building), or to pursue some other type of financial scheme. It's not easy to make an exhaustive list of the other possible financial schemes because there are many possibilities. For example, a properly documented and agreed upon private loan to an acquaintance can qualify as an investment. The purchase of various derivatives products might qualify as an investment as well. Even the purchase of rare grapes for the purpose of creating a unique wine could qualify as an investment. It's impossible to describe every possibility here, of course, but this should give you a general understanding of what I mean by a financial scheme.
...in order to obtain a return...
Investing requires that the deployment of the funds is done to obtain some financial return. If no return is expected or desired, then the deployment of capital is more like a donation or a purchase depending on the circumstances. Financial investing requires that it is done for the purposes of growing your capital base by receiving a return on the invested funds.
Investing requires that we are reasonable in our expectations of the financial return from our endeavor. If we are unreasonable or foolish, it's not investing in my opinion. A reasonable person using reasonable analysis techniques (they don't have to be complicated, just sound and reasonable) should be able to agree that a positive return is possible. This means that if unfounded, biased, or inappropriate techniques of analysis are used in order to determine what the potential return is (either expected return), it is not investing in the proper sense of the word. For example, using deeply incorrect assumptions that you know don't make sense to calculate your expected return wouldn't hold up to this standard. You wouldn't be investing here, but would instead be fooling yourself and possibly speculating. Additionally, not dong any analysis whatsoever before deploying capital would preclude the activity from being called investing. The analysis doesn't have to be complicated (although deeper analysis is likely better), but some sort of thought must be given to what is occurring if we are to call the activity investing.
...that the risk-adjusted or expected return is positive.
This point speaks to how we calculate the return. We state that the return has to be positive, but we need to know how to calculate the return. In calculating the possible return, a more sophisticated investor should adjust for risk, calculating what is called the risk-adjusted return or the expected return (these two names can generally be used interchangeably in a non-academic or unsophisticated setting). There are complicated mathematical formulae for calculating risk-adjusted numbers, but what is meant here is something more basic: the return you expect to get should from your investment should be the adjusted for risk, with less probable outcomes discounted more intensely. In other words, the return can be thought of as a weighted average of the possible returns, each return weighted by its probability of occurrence. Going further, this means that investing requires that the expected return is positive. That expected return might never occur, but at the outset (when we deploy the capital) the expected return should be positive. No rational individual would deploy capital into a financial scheme that has a negative expected return.
Speculation isn't investing; neither is work or saving!
Investing, in the financial sense of the word, can be distinguished from other uses of capital or energy. Investing is not:
Keep the definition of investing in mind to avoid foolish speculative bets or to confuse saving with investing
In conclusion, we see that investing is a specific type of deployment of capital and is distinguished from work, saving, and speculation. Keeping the definition of investing in mind could help us differentiate between investing and speculation by applying the definition in a disciplined way before we deploy our capital. Investing is a fundamental part of individual wealth-building and it allows for a society to grow and prosper, but it should be done wisely and carefully so as to make sure that foolish bets are not being taken.
And now, given the rise of cyrptocurrencies and crypto assets to quasi-mainstream financial assets, we're dedicated to providing quality, relevant, and interesting material on cryptocurrencies and cryptoassets. Articles on Bitcoin, Ethereum, Ripple, Cardano, and many more cryptocurrencies and cryptoassets can be found on Pennies and Pounds - all that in addition to a plethora of information on what cryptoassets are, how the entire crypto industry came to be, blockchain/immutable ledger technology, mining, proof of work, proof of stake, and how to prudently invest in crypto if you are so inclined (based on your risk tolerance and ability to withstand the volatility that will come with a crypto portfolio).