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Investment Speculation and Gambling

    Mr. Shyam | Tuesday, November 10,2009, 03:49 PM
 

Investment, Speculation & Gambling, these words are very common in the stock market especially the first two, but the fact is that most of us do not understand their actual meaning and at times we use them interchangeably. Now let us understand these terms keeping in mind the market.

Investment

The term investment has many facets and is used in many fields like management, finance, economics etc. but we will be strictly sticking ourselves to the meaning that is apt keeping in mind the financial market.

Warren Buffet one of the most respected investors all around the world and CEO & Chairman of one of the world famous Investment Company Berkshire Hathaway has opined that if a person invests money in the market with even a hint of thought of selling it once the price rises is not at all an investment. When you ask any person to define the term investment one of the most common answer would be that an investment is nothing but to put your money into something. One of the best definitions of investment is given by Frank K Reilly and Keith C Brown. According to them investment is defined as Current commitment of resources for a period of time in order to derive future payments that will compensate the investor for;

  • Time for which the funds are committed
  • Expected rate of Inflation
  • Uncertainty of future of payments

Or it can be defined as the trade-off of present consumption of money for higher consumption of money in the future this is called as saving and the activities that we carry out to increase the savings is called as investment.

For example; a person purchases shares of Reliance companies worth 10,000 intending to hold them for a long term and expecting at least Rs 50 dividends on them.

An investment is said to be genuine if it has been made keeping in mind certain expected rate of return in mind. In the above case if that person had just taken the reliance shares without expecting the dividends then it is not a genuine investment.

There are three things that compensate the investor collectively form the Expected Rate of Return such as;

  • Time
  • Inflation
  • Uncertainty

The first one is the time for which the funds are committed. Let’s think that Mr. X has lot of excess money and he does not know what to do with that so he just digs a hole on the floor of his home and buries all the excess money for two years and after two years he takes the money and it should not be surprising for him to find out that the amount has not changed. It is just to show that if he had invested the same thing like markets or banks or post offices then he would have received some rate of interest and this is called as pure rate of interest.

Second one is rate of inflation. Just think that you have 100 rupees now in your pocket and with that you can buy 2 kg of rice but instead of that you choose to invest it in market for one year. There is something called as inflation which changes the purchasing value whenever there is fluctuation in its value so if the inflation rate is 4% per annum you would definitely expect the investment that you have done in the market to give you a return of 4 rupees so that you can buy the same 2 kg of rice after one year. This is called as nominal rate of interest and it is the sum of pure rate of interest and compensation for inflation.

The third and the last one is uncertainty of the future payments. The payments that we are expecting are uncertain hence the risk element is involved and the investors are ready to take that risk and in return they expect something called as risk premium. Risk premium is nothing but the risk free returns plus extra returns for risk.

Speculation

Speculation as in Investment has many meanings but when it is used keeping the finance in mind means that the money is spent or lent in the market to purchase instruments without much knowledge. Speculation is defined as buying and selling the instruments without taking their delivery. It is also called as non-delivery based transaction. Speculators are those who have no exposure to underlying asset. The speculators are trading for very short duration of time and their main motive is to earn profits as there are changes in the prices within a short duration of time. The speculators are exposed to risk as they are employing their assets without much study and in the process provide liquidity in the market. If you go by the definition given above then the day trading that happens in the stock exchanges are definitely nothing but speculations as there are so many people buying and selling the shares as there are changes in their prices.

For example; a person buys 50 shares of BHEL at 3000 rupees and as a result of market fluctuations their price rises to 4000 rupees just in few minutes then the person sells off those shares to get a profit of Rs.1000 this is known as speculation.

Gambling

Gambling is an artificial activity which is solely based on the intuition and it is an artificial activity and is not at all dependent on the economic activity. The gambling does not involve any kind of analysis. The money is just employed and the chance of winning in that particular gamble is very less. The gambling is of very short period when compared to speculation and is solely based on the intuition.

For example; a person putting all his earnings in horse race or in a casino or in the cards is said to be taking a gamble as he doesn’t know if he is going to win and there are very less chances of him winning that.

Mr. Shyam

IndianMoney.com Research Associate

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