Investors often have a difficult time differentiating between investing and speculating. In this article, I parse out the difference in order to help you avoid gambling as much as possible in your portfolio.
Ultimately, it is impossible to eliminate risk from your portfolio. Virtually every investment decision you make comes with some risk because you are making a judgment on what the future will hold. But the difference between investing and speculating is that investors eliminate as many of the future unknowns from your decision making as possible. Speculators are guessing that something will happen — it is usually an event with a binary outcome, which, if you guess correctly, you will do very well.
In order to explain the difference between speculating and investing let us look at the following three assertions.
- Coca-Cola (NYSE:KO) will sell more beverages 15 years from now than it does today.
- Coca-Cola will announce positive Q2 earnings results.
- Peregrine Pharmaceuticals (NASDAQ:PPHM) will find a cure for cancer.
I took the first assertion from Warren Buffet, who has a lot of confidence in its validity. The assertion is based on several factors, including:
- Coca-Cola has a long history of increasing its sales.
- Coca-Cola has universal brand recognition.
- Coca-Cola sells products that are affordable to virtually everybody in the world.
- The global population continues to grow, giving Coca-Cola a larger customer base over time.
While there is no logical necessity in any of these statements, history has proven all of them to be correct, and a world in which one or more of them will not hold true is a world that is very different than the one we live in. Therefore, the above statements comprise a very compelling investment thesis — although there is risk that one or more of them won’t hold true, it is very unlikely. Furthermore, Coca-Cola is extremely well-positioned to overcome adversity. For instance, if a new company comes along with a popular product Coca-Cola has the power to advertise, lower its prices, or even buy out its competition. If people start to consume different kinds of beverages, then Coca-Cola can simply change its beverage offerings.