Seth Klarman, in the first few pages of his Margin of Safety, makes a distinction between investment and speculation. Any purchase that generates cash flows for its owners while they own it is an investment while one that does not is a specualtion. This is an important distinction. By this definition, buying stocks and bonds are investments. But buying commodities, art and precious metals as investments, in the hope of being able to sell them off for a profit in the future are all speculations.
The difference is that in the latter case, one is buying something and hoping that there will be someone (or many) who will be willing to bid a much higher price for it in the not too distant future. Does this sound familiar? If it does, it might be because this closely resembles the definition of the Greater Fool Theory. Thus, buying a Raja Ravi Varma because you would like to admire it in the privacy of your home is not speculation, while buying one because you have read that the price of art is going up in the Economic Times definitely is. Similarly, buying gold jewellery for your daughter's wedding is not speculation, but buying gold because you believe that the relentless rise in its price in rupees over the last decade will continue on in the future definitely is.
In both the above examples, the important difference is in the intention of the buyer. In the first alternative in both cases, the intention is to buy because the buyer appreciates the underlying or intrinsic value of the purchased item, and derives some utility from it. In the second alternative in both cases, the purchase is made purely with the intention (or rather hope) of being able to find a buyer who can take the item off your hands at a much higher price than what you paid.
This difference in intention can be applied while buying stocks and bonds as well, to classify the purchase as an investment or a speculation. If one buys a stock because one read glowing media reports about it, was influenced by endless plugging on financial channels, or in response to a 'buy' signal from some sort of technical analysis, and this purchase is completely done without regard to, thinking about and understanding what the value of the underlying business would be to a long term owner, then that stock purchase falls in the realm of speculation.
The difference is that in the latter case, one is buying something and hoping that there will be someone (or many) who will be willing to bid a much higher price for it in the not too distant future. Does this sound familiar? If it does, it might be because this closely resembles the definition of the Greater Fool Theory. Thus, buying a Raja Ravi Varma because you would like to admire it in the privacy of your home is not speculation, while buying one because you have read that the price of art is going up in the Economic Times definitely is. Similarly, buying gold jewellery for your daughter's wedding is not speculation, but buying gold because you believe that the relentless rise in its price in rupees over the last decade will continue on in the future definitely is.
In both the above examples, the important difference is in the intention of the buyer. In the first alternative in both cases, the intention is to buy because the buyer appreciates the underlying or intrinsic value of the purchased item, and derives some utility from it. In the second alternative in both cases, the purchase is made purely with the intention (or rather hope) of being able to find a buyer who can take the item off your hands at a much higher price than what you paid.
This difference in intention can be applied while buying stocks and bonds as well, to classify the purchase as an investment or a speculation. If one buys a stock because one read glowing media reports about it, was influenced by endless plugging on financial channels, or in response to a 'buy' signal from some sort of technical analysis, and this purchase is completely done without regard to, thinking about and understanding what the value of the underlying business would be to a long term owner, then that stock purchase falls in the realm of speculation.
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