Investment and speculation are two concepts widely used in the world of the stock market. They are often used interchangeably, although they have very different connotations from the perspective of the value investing.
In this article we will see the difference between investment and speculation according to Benjamin Graham, we will analyze the characteristics that a financial operation requires in order not to be considered speculative and we will finish clarifying the separation between both concepts.
Definition of investment and speculation by Benjamin Graham
Benjamin Graham defines investment in his book "the smart investor" as follows:
"An investment operation is one that, after an exhaustive analysis, promises security for the principal and an adequate return"
Speculation is defined by Graham as opposed to investing:
"Operations that do not meet these requirements are speculative"
The 3 requirements of a non-speculative investment according to Graham
- Comprehensive analysis of the company
For Graham, a comprehensive analysis is:
"The study of the facts in light of the established security criteria"
Therefore, an investment that is made without prior analysis will be speculative. The greater the depth of analysis, the less speculative the investment will be.
- Security of our investment
According to Benjamin Graham, this implies:
"Protection against losses under normal or reasonable conditions or variations"
As we can see, we are facing a quite ambiguous or subjective concept, so this will depend on what we can consider normal conditions. Warren Buffett is much more forceful with the demand for security in its investments with its historic phrase:
Rule # 1 is never lose money. Rule # 2 is to never forget rule # 1 ”
- Adequate performance
Graham considers adequate or satisfactory performance:
"Any type or amount of return, no matter how small, that the investor is willing to accept, as long as he acts with reasonable intelligence"
Once again we are facing a subjective concept, since it will depend on the investor's profitability objectives.
Is it possible to invest without speculating?
For Graham, any financial transaction that does not meet the requirements just listed will be considered speculation. However, I believe that it is necessary to clarify the difference between investment and speculation by Benjamin Graham.
First, we must start from the fact that all investments are subject to some degree of uncertainty, no matter how small. As the possibility of losing our invested capital is always present, we can say that all investment implies speculation to a greater or lesser degree. There can be speculation without investment, but no investment without some speculation.
Although the economic concept of “risk-free rate” exists, it is still an abstract concept that does not exist in practice. For many the American bond or the German bond are the practical representations of this concept. However, it is possible (but also unlikely) that these countries may not pay if some totally unforeseen event occurs, such as a great war or a great natural catastrophe.
What we must aim to do is minimize speculation to maximize the safety of our investments and, consequently, minimize risk. We have three methods to reduce speculation and therefore increase the security of our investments:
- We invest in easy-to-value companies, which tend to be the ones with the most predictable income.
- Perform deeper analysis of companies.
- Better analyze our investments, increasing our knowledge and experience.
It is the combination of these three methods, along with a great deal of common sense and experience, that has made Warren Buffett the third richest man in the world and the best investor in history. Investing may not make it to the list of the richest in the world of Forbes magazine, but with a little effort you will achieve a good return on your savings by sleeping well at night.