Difference between Investment and Speculation and the factors that an investor should consider.

The terms ‘investment’ and ‘speculation’ are overlapping and used interchangeably; however, the two are quite different. Speculation is an investment of funds with an expectation of some return in the form of capital profit resulting from price change and, is relatively a short term investment. The decisions are based on ‘market waves’, ‘rumours’, or perception of the investor and, the degree of uncertainty of future return is definitely higher in this case. In case of investment, the investor has an intention of keeping the investment for some period whereas, in speculation, the investor looks for an opportunity of making a profit and ‘exit out’ by selling the investment. In speculation, there is an expectation of movement of prices and the speculator wants to capitalize that opportunity. If he expects an increase, he buys and takes a long position. On the other hand, if he expects a decrease, he sells now to buy it back at a later stage at a lower price. Here, gambling is the assumption of risk even without having a prospect of a risk-premium. Whereas, Investors are willing to take risk because they expect to earn a risk premium as they find a favourable risk-return trade-off in taking speculative position and, fundamental and economic analysis is the basis of such investment.

Where one stresses upon the fundamental analysis for selection of investments, some basic factors that should be considered while investing cannot be ruled out. They are:

  1. Liquidity, meaning that the investment should be convertible into cash at a fair price with ease. This provides a chance to the investor that he can exit and get back his money. Thus, an investor should actually be looking into building a portfolio that contains a good portion of investments with relatively higher degree of liquidity. For instance, money deposited in savings a/c and fixed deposits a/c in a bank is more liquid than the investment made in shares or debentures of a company.
  2. Risk of an investment which is an inseparable part of investment should be analysed from two different aspects: safety of principal and stability of return. For example, bonds issued by the RBI are relatively safer investments as compared to the bonds of a private sector company. Moreover, investment made in debentures of a particular company is safer than preference shares of that company. Further, investment made in preference shares is still safer than that in the equity shares of the same co. Secondly, the returns from the investment should be stable and not fluctuate. For example, returns from savings a/c, fixed deposits a/c, bonds and debentures are stable but the expected dividends from equity shares are not stable and the rate of dividend may fluctuate depending on the earnings of the co.  Stability of return as a factor in considering investment options however, depends on the risk profile of the investor.
  3. Capital appreciation is another factor. Some investments such as land, buildings, equity shares provide opportunities for capital appreciation whereas, in case of fixed deposits and debentures, the initial value and maturity value remains the same. One needs to keep in mind that chance of capital appreciation implies chance of capital loss as well and, this can add to the risk of the investment.
  4. Investment horizon, which refers to the planned liquidation date of the investment, should be considered by the investor while deciding upon investment. The maturity period makes it more attractive if it coincides with the date when funds would be needed.
  5. Tax aspects should also be taken into account with respect to tax treatment of initial investment, return from investment and investment proceeds. For instance, investment in PPF has tax benefits. Similarly, investment in equity shares entails exemption from taxability of dividend income but the transactions of sale and purchase are subject to Securities Transaction Tax. The treatment of tax also depends upon the type of the investor. So, if one has to consider between 8.5% PPF and 8.5% debentures, former should be preferred as it is exempt from tax whereas, the latter is subject to tax in the hands of the investor.

All the above given factors should be considered simultaneously and not one by one. The investment decision should thus be based on the overall effect of all these factors.


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