this site demands javascript
06/11/2024

We found our disciplined friend and noticed that he was in good spirits. After greeting us, he says: I have followed your recommendations and I have opened an account to start investing. I am already authorized to use margin, have access to the options’ market, and subscribed to information services dedicated to identifying assets that are going to change in price.


Although investing and speculating have many things in common, such as requiring an investment account and choosing what and when to buy and sell, the reality is that both concepts follow very different processes and assumptions.


Investing requires an analysis and a projection that will lead us to estimate with a certain level of confidence an increase or decrease in value (the investment thesis). This change in value can come from several causes, for example, a jump in units sold, a relevant change in profit margins, and even the appearance of a buyer for whom, whatever we have in our hands, represents a very different value than for us. In an investment, one must wait for circumstances to evolve by confirming or denying our investment thesis.


An example of investment is the structured and in-depth process by which Berkshire Hathaway, and its leader Warren Buffett, select the companies that will be part of their different portfolios. This type of analysis and projections consider many variables, both internal and external, with great emphasis on both the quality of management and the strength of the competitive position of the company being analyzed. Once the company has been selected, the positions are acquired in a way so as not to alert competitors, and they are held for as long as necessary until changes in the value of the investment are observed.

Speculating also requires analysis and projections but focused on other variables and other timeframes. When analyzing for speculative purposes, it is not so much the intrinsic value that matters as the short-term projection of prices. In fact, the reasons why the price might vary may have nothing to do with fundamentals but may come from purely technical or operational situations in the markets (e.g., temporary oversupply). Finally, the periods between buying and selling are usually very short. In-and-out. Fast. Earning little but earning often. It is a statistical and risk control game, seeking to be right more than half of the time.

An example of speculation is the multivariate and automated processes by which asset manager Renaissance Technologies, and its late leader Jim Simmons, have used massive data collection and super-sophisticated statistical analysis to identify patterns that could indicate the imminence of a price change, optimally executing the necessary operations, maximizing the winnings odds, and controlling risks.

In general, individuals like our friend do not have the time or resources like Berkshire Hathaway or Renaissance Technologies, and therefore should aim to delegate the investment or speculation processes. To this end, both the composition of the portfolio and the selection of individual securities, either through actively managed or indexed funds, are usually delegated to professional advisors and money managers.

As for the possibility of speculating on their own, individuals can try to do so since it is an interesting and fun activity that in some cases can generate profits. The quasi-random nature of the price movements tends to distribute large doses of humility to those who try it, granting them profits one moment, only to take them away the next. The risks of speculation are multiplied by using margin, either for leverage or to take short positions, or derivative instruments such as options, which carry intrinsic leverage.

Our recommendation is to delegate the asset allocation and portfolio management for most of the assets in the portfolio and, if the clients insist, have them independently invest or speculate on a small portion of the total portfolio, trying to focus on the assets where they have the most experience and knowledge.

Disclaimer: The information provided herein is for educational purposes only. Portfolio Resources Group does not guarantee the accuracy of any tax advice, as we do not provide tax or legal advice. Consult a tax professional to make sure the recommendations are appropriate for your situation.

Author: Roberto Isasi GO BACK