Do you know the difference between an investment and a speculation? Most investors don’t.
In 1934, Benjamin Graham attempted to delineate investing from speculating in his seminal book Security Analysis. “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return,” posits Graham. “Operations not meeting these requirements are speculative.”
When the subject turned to investing, Graham rarely swung and missed, but here he does. His delineation is vague and ethereal at best: “thorough,” “promises,” and “satisfactory” are too subjective. They tell us nothing, so they offer no insight.
In 1938, John Burr Williams published The Theory of Investment Value, which I believe offers a more concrete concept of an investment. Williams posited that common-stock value is determined by the present value of future cash flows – in the form of dividends distributed to investors.
I would extend Williams’ supposition to any cash flow that’s distributed to investors: rents, interest, royalties, distributions. By my definition, any income-producing asset can properly be called an investment.
And if an asset fails to distribute income? Then it’s a speculation. Commodities, gold, non-dividend-paying stocks, or any other non-income paying asset is a speculation. (I could technically include non-dividend paying stocks on expectations of their paying a dividend, but in practice I’ve found it too much guesswork to make the exercise worthwhile.)
In summation, any asset that regularly and predictably distributes cash to the investors is an investment; everything else is a speculation.
I say everything else is a speculation because the speculator is purchasing only with a future sales price in mind. The speculator is attempting to forecast future market psychology and to accurately gauge how other speculators will value the asset in the future.
Don’t misunderstand, I’m not denigrating speculation. We all speculate. If you’ve ever topped off your gas tank because you anticipate higher gas prices, you’re speculating: You think gas prices will rise; the gas station owner thinks prices will remain the same or fall, or he’d already have increased the price.
What’s more, most investments have a speculative component. Dividends, royalties, rents, income, and distributions are tangible variables for deriving asset value, but investors also purchase these cash flows anticipating other investors will value them differently in the future, or that the cash flows themselves will change.
I’m an investor first, but I’m also a speculator. My personal portfolio is overwhelmingly composed of assets that generate and distribute cash flow to me. But my income investments also have a speculative component: I anticipate price appreciation based on my expectations of a change in future market psychology. That said, the current cash flow is really the driving factor.
The same philosophy permeates the High Yield Wealth portfolio: Every pick has an income component, so every pick is an investment, properly speaking.
The High Yield Wealth portfolio is also divided into two segments based on the degree of the speculative component. One portfolio is composed of staid and higher-yield income investments, with less of a speculative component. The other portfolio is composed of lower-yield investments with more of a speculative (greater price-appreciation potential) component.
So if someone asks you, what’s the difference between an investment and a speculation? Now you know.
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