Think You’re Investing? If It Feels Like a Gamble, You’re Probably Speculating.

The Difference Between “Speculating” and “Investing”, and How to Craft a Sound Investment Thesis (Despite What Your Friend on r/WallStreetBets Tells You).

Maybe you haven’t felt this way… and maybe you are absolutely 100% risk-averse, but isn’t there just something truly spectacular about that ‘butterfly’ feeling we get in our gut? I mean, no matter how cautious of a life we live, we often feel the most alive in those moments when we are the most unsure. I’m talking about those moments when you are about to ask a girl (or guy, or whatever) out for the first time and don’t know if they like you back. I’m talking about those moments when you have a major career opportunity that requires you to jump into the unknown. Hell, I’m even talking about those moments when you are about to ride shotgun with that one friend who thinks that their Hyundai Tucson is a Formula 1 race-car and mistakes the highway for the ‘Circuit de Monaco’.

You can argue whether that it’s a good feeling or a bad one, but nonetheless, it is in these moments that we are most attentive and most engaged with the world around us — and funny enough, are also the most in control of our actions.

Perhaps this heightened awareness is our primal instinct kicking in — a clarion call that we’re sailing into a storm. It rouses us from the everyday ‘auto-pilot’ to declare ‘all hands on deck.’

But here’s the catch: when it comes to managing money & investments, should we really seek the same wild excitement that comes with such gambles? I would argue that the answer is most definitely no, and while I do believe wholeheartedly that speculation DOES hold a rightful place in the world and our lives (keep reading, we’ll get there), it is critical that we differentiate between “speculating” and “investing” — as to “invest” money requires a sound investment thesis based upon a fundamental understanding of a given asset, defined and thoughtful strategy regarding the protection of the principal of the investment, and the emotional discipline to enact and enforce the investment strategy.

If you want to stop reading here, go ahead. But if you feel that you hold the emotional discipline to continue, then you are already well on your way to grasping this concept.

Investing versus Speculation

“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” — The Intelligent Investor (1973 revised edition) by Benjamin Graham

An investment is a calculated procedure requiring the investor to conduct thorough and thoughtful due diligence with the aim of growing their savings over time. Anything short of this is speculation. Reading online that a specific cryptocurrency is ‘going to go to the moon’ and buying the coin without analyzing the asset or constructing a sound investment thesis, is speculating. I will even be so bold as to say that just placing your money into an index fund such as the S&P 500 without properly taking the time to understand what it is that you are doing, is speculating. The point I am trying to hammer across, is that investing is a deliberate action based on a specific strategy, whilst speculation is everything less than that.

At a baseline, speculation can be as simple as mindlessly pulling a slot machine or buying scratch-off tickets. More sophisticated forms include listening to a podcast presenting bull or bear cases on a stock and then purchasing that stock based solely on such recommendations, or acting on news that the real estate market in St. Petersburg, FL is surging in value and purchasing properties without sufficient due diligence of the market or asset class. Conducting basic research or partially developing a thesis does not necessarily equate to a solid foundation for investing. A true investment strategy is thoughtful and comprehensive; anything less is speculation.

Considerations on How to Wisely Craft an Investment Thesis

The first rule of investing is: Don’t lose money. Rule number 2: See rule one again. Fundamentally, the reason we even invest in the first place is so that our cash — itself a representation of a redeemable store of our own time and energy that is exchangeable for the time and energy of others (a.k.a. goods and services) — may benefit from the principle of compound interest to grow over time, theoretically yielding us with even more “time and energy”.

As an investor, you primarily acquire capital in two ways: your savings, and the savings of others (your partners, who entrust you with their “time and energy”). While you never want to lose any of your own hard-earned money, it is paramount that you protect the money of your partners first and foremost.

A loss of our principal investment represents a loss of our own time and energy, and depending upon the scale of the investment, might represent a lifetime’s store of our time and energy, erased.

Given these stakes, I think that Ben Graham’s definition (see above) is a perfect anchor for what goes into a wise investment thesis, holding within it three main criteria:

1. Requirement of diligent research and thoughtful strategy. The investor should fundamentally understand the asset in which they are investing, be able to outline all foreseeable risks and opportunities, and assert a definitive (yet adaptive) position. They should maintain a critical and skeptical perspective throughout this process. Given our inherent imperfections as homo sapiens, there will always be some degree of speculation present in everything that we do. To account for this, the wise investor should account for an additional yet reasonable “margin of safety” to ensure that the investment is adequately shielded as best as possible from the unknown.

2. Protection of principal. The investment itself should contain a store of value that has significant relevance and value potential well into the future, and not be based solely upon the fickle opinions of ochlocratia. Even in the worst-case scenarios, your losses should be minimal. It’s like what former Gucci CEO Domenico De Sole said about Bernard Arnault; “Even when he loses, he wins”. As an investor, be like Batman, and always have a contingency plan for when things go south, because whatever can go wrong, will go wrong. Ensure that your strategy allows for the defense of your principal investment, and don’t cry over principal that you willingly left exposed to the elements.

3. Investment returns should be both realistic and worthwhile. Understand your goals, but don’t get overly greedy. If your goal is to grow your savings with minimal energy expenditure, then expect market returns. If you are hoping to “beat the market”, then you must be prepared to spend more time and energy to achieve those results (at least sustainably overtime), and outline an outsized return that is worthwhile for the extra expenditure. If you are having trouble outlining an investment that is worthwhile in this capacity, then perhaps focus on increasing the amount of available capital that you have to invest (for most people, this will be through increasing income). There is a common adage that while time in the market will help you achieve the greatest returns (and I only mostly agree with this statement), the wise investor always is cognizant that the market can change, and no natural law guarantees that assets will always appreciate (back again to Murphy’s Law). For anyone who has played poker, there comes a time when you must be satisfied with your winnings and walk away from the table, lest you risk losing everything as the tides turn.

One final consideration before you craft your investment thesis, is to always prioritize soundness over mere validity.

What do I mean by that? In logic, a valid argument is one where the conclusion logically follows from the premises, such that if the premises occur and are ‘true’, the conclusion ‘must’ also be true.

Consider wanting to drive to your friend Mounir’s house as quickly as possible without regard for cost or distance; your only goal is the shortest possible trip. A valid argument might be “Well shorter routes are faster! And if I take 9th Street, I will be taking the shortest route, therefore I must be taking the fastest route to Mounir’s house!”. Though valid, the argument’s premises may not be rooted in fact. While distance significantly affects travel speed, it’s not the sole determinant of trip duration. You must account for speed-limits, traffic, road conditions, stop lights, et cetera. If I had simply settled for a valid thesis, there is a very good chance I might have missed the sound thesis. For an argument to be sound, it must be both valid in structure, and its premises be true. Creating a valid argument is possible for nearly any claim, but uncovering the ‘truth’ holds far more value than merely appearing ‘right’.

A Case for Speculation

Speculation is often painted with a broad brush, but it is important to remember that the principles I outlined for investing — applying a sound thesis for action (or inaction), with protection of your principal assets, and maintaining a realistic perspective and worldview — should be applied in every financial decision. However, when we find ourselves in the trenches of reality, we do not always have the luxury of a bird’s eye view to guide us, and decisions must often be made in real-time with limited information, but this is not necessarily always a negative.

The European exploration and colonization of the 15th century, for all its associated traumas and evils — which must be acknowledged — also opened up global trade networks and exchanges, and was largely driven by speculation. The Silk Road originated in large part from speculative ventures aiming to trade valuable resources and ideas across continents as a means for economic growth in China. In 2024, the development of Artificial Intelligence continues to be driven largely by speculative funding in areas like cognitive computing, neural networks, and machine learning algorithms, which promise significant economic and societal benefits — and risks.

As a founder, exploring these uncharted paths and pushing the boundaries of what is possible is noble. As an investor, however, you must not forget the critical importance of preserving capital. Consider allocating a certain amount of your capital towards speculative investing — such as venture capital, emerging market opportunities, or breakthrough technologies — yet do so with the assumption of 0% returns. Imagine that this portion of your money was set ablaze — would it change your life for the worse? Could you afford to lose it without impacting your quality of life or the survival of your firm? Only if the answer is ‘ NO! ’, should this be the money you use for speculative purposes. Is there a specific percentage of your portfolio that should be allocated for speculative spending? No, this call must be made on a case-by-case basis, and is subject to great variation.

Treat the funds you allocate for speculation as a form of mental exercise, allowing you to engage with industries and opportunities outside your usual scope. Since you’re assuming a 0% return, any positive performance is a bonus. Should any of your speculative ventures show exceptional promise, that might signal a sector ripe for deeper investigation and potential investment.

It is easy to look like a genius in the short-term, or wise by simply living long enough. It is through the focused-grind that we achieve real results, and build sustaining futures.

March 12th, 2024 , Erik Hempel … somewhere in the Northern Hemisphere.