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Revised April 19, 2006

What is Investing? - Macroeconomic Articles on TheDOCument.com

There is a fine line between investing and speculating, and because both activities are implemented via identical actions, namely buying and selling assets, many would argue there is no difference. After all, investing involves risk, risk implies uncertainty, and uncertainty implies speculation. But there is a telling difference below the surface: one that involves an interpretation of intent.

Investing is a term that implies the intent to build wealth. Wealth is built by allocating saved capital towards processes that create more capital. In other words, the intent of an investment is to produce something. On the other hand speculators have no intention of producing anything other than a profit. Speculation, therefore, is the intent to capture or transfer wealth via price changes.

Defined formally:

investment: the allocation of capital toward productive processes with the expectation of making a profit on such production

speculation: the purchase of an asset with the expectation of making a profit from price fluctuations

Note that these definitions are mutually exclusive. Undoubtedly, bells are ringing in your head. If one purchases shares in a company, isn't the underlying expectation to make money from a price fluctuation? The question presents an important philosophical point that ultimately highlights the difference between investing and speculating. Is the purchaser acquiring shares because he believes they are undervalued based on an analysis of cash flow and assets or is he purchasing shares because he thinks they are temporarily oversold and should snap back up? Perhaps one way to answer the question is by asking whether the analysis is fundamental or technical. Within the technical realm, I would include traders who use gut feel or their perception of the psychological environment to capture short-term price changes. After all, what is technical analysis other than a pictoral expression of the underlying psychology?

Granted, fundamental purchasers may use technical tools for choosing an entry point, but in this case the speculation is done BEFORE the purchase in an attempt to find a cheaper entry point. The speculation is nonetheless a separate activity from the investment.

You will note that in other portions of this site, I frequently the term "trader" rather than "investor" or "speculator." The act of trading is done by both investors and speculators as part of their efforts. Trading is simply an exchange and is the act of opening or closing investment or speculative positions, both of which are exercised by the author and his readers.

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