The Amateur Financier

I thought that this Monday I’d look at an aspect of personal finance that I wrote quite a bit about in the earlier days of my blog, but haven’t touched on much lately.  There are a number of investment options that you can take advantage of in the world, and they vary greatly in factors like level of risk, potential return, and chance of losing all your cash (and then some).  For the most part, I tend to focus on the investments with lower levels of all three factors, looking at things like mutual funds that are low risk, have a low chance of losing money, but in turn tend not to offer a great deal of return.

Speculative items, on the other hand, have high levels of risk (including the risk of losing all your money) but also the possibility of great returns.  Given this, you can probably imagine that there is quite a bit of interest in these speculative investments, particularly from people who hope to use them as a means of building up a nest egg in a matter of years, not decades.  (The tendency for much of the Western world to favor quick fixes rather than the slow and steady route being an issue for another day.)  So, let’s talk a bit about these speculative investments, so you can decide if they are for you.

Q: What sort of Speculative Investments Are There?

A: Quite a few investments are considered to be speculative; the main ones typically cited are forex, futures, and options.  There are also riskier types of more common investments that are considered speculative, such as penny stocks.  The main connecting factor for all the investments that are considered speculative is, as mentioned, the generally high level of risk and the potential for reward.  For this reason, they are generally not recommended for new investors, and are strongly discouraged for things like saving for retirement, although that doesn’t stop people from doing so…

Speculation isn't REALLY gambling, but it does come with some pretty high risks

Q: Should I Invest in Speculative Options?

A: That’s a hard question for me to give a solid yes or no.  There is quite a lot of risk in speculative investments, but as mentioned, there is much potential for gain.  Many advisors and commentators discourage their advice seekers from using speculative investments at all, although I don’t think that hard line approach is the best.  Assuming you are in good financial standing and don’t put too much of your money into speculation (like gambling, you should only speculate with money you can afford to lose), I say speculation can be a part of your portfolio.

Q: What Should I Do Before I Start to Speculate?

There’s any number of tasks you should complete before putting your money into speculative opportunities.  First, I’d make sure that I’ve done all the personal finance basics before even considering speculation; make sure you have your debts paid down, an emergency fund built up, and adequate retirement savings (in non-speculative investments) to retire on time, if not early.  Then, be sure you understand the type of speculation you are doing inside and out; many speculative websites offer ‘practice accounts’, allowing you to get a feel for such investments.  Lastly, make sure you have a buffer fund, beyond what you are actually investing; as noted, many speculative investments use leverage, and you can lose more money than you actually put in, and will need a source of funds that doesn’t cause you to dip into savings or emergency funds.

Q: How Much Money Should I Put Into Speculation?

A: That is a tough one; many advisors will again say that you shouldn’t put any money into speculative investments, and that is certainly one option (and the one should take, if you don’t understand the investment options or can’t afford to lose the money).  But if you have your finances in order, you can afford to put some money towards speculation.  I’d say no more than 10-20% of the money you have available for investing outside of retirement savings could go to speculation (and this value includes that buffer fund mentioned earlier).

Q: What Speculative Investments Should I Choose?

A: That’s way, way beyond my ability to help as a financial novice.  As I’ve mentioned, most websites I’ve seen in the speculative investment business offer practice accounts for you to get a feel for the investment style.  My best suggestion is to do some reading (you can start with the links here) about these speculative investments, find one (or more) that appeals to you (it’s alright if none do), and then open a practice account to get your footing.  Perhaps you’ll have a knack for it, and can soon share advice with amateurs like me.

That’s it for speculation at the moment.  Anyone currently engaged in speculation who has their own advice to offer?

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Many investment advisers suggest using a portion of your investing funds to engage in speculation.  (Even I did back when I created my little investment pyramid.)  For many people, there’s a natural tendency to gravitate towards speculation, and if you don’t take care to limit the amount of money you put at risk, speculation can eat up a great deal of your portfolio.  To prevent that, the suggestion is to put five to ten percent of your portfolio value into speculative ventures.  You’ll get a taste of the rush of speculation while still keeping the vast bulk of your money in the safe investments that might be kind of boring, but will provide slow steady growth over time.

So, once you know how much money you can speculate with, it’s time to hop into the car and drive to Las Vegas, right?  (Or to Atlantic City, for those of us nearer to the east coast.)  Well, not quite; there is a difference between speculation and gambling.  If we go to Dictionary.com, we can find speculation defined as: engagement in business transactions involving considerable risk but offering the chance of large gains, and gambling defined as: to stake or risk money, or anything of value, on the outcome of something involving chance.

What does this difference between gambling and speculation mean to us?

In a nutshell, it means that gaining more knowledge should improve our results in speculative ventures, but not in gambling.  This sounds reasonable: gaining more knowledge about how international currency rates fluctuate should (emphasis on should) help you make more money in the Forex markets, for example, while no level of mastery will improve your odds at the Roulette wheel.  (We could make an argument that knowing more about a sport and the particular teams playing could improve your ability to make money on sports betting; but the spreads on most games will change it back into a more luck-based outcome, at least in theory.)

The plan for your speculation should be to gain knowledge into the particular method or methods of speculation, attempt to figure out your best choices, and put a small portion of your investment money into these vehicles. If you’ve chosen your speculative vehicles correctly, you can see your money value greatly increase; the high level of leverage and risk offered by most speculative methods means that great profits (and equal or greater losses) are possible.  Should your speculation rise in value, your best course of action will be to take some profits, put them into safer vehicles like mutual funds, and if you want, to keep speculating with the ‘House’s Money’, to use a gambling term.  If you lose some or all of your money, take your losses (you did remember to keep your speculation to a small portion of your investments, right?), rethink your speculation, and if you still have the desire to speculate, put a small portion of your new investment money into speculation.  In this way, you can get the thrill of speculating and some of the potential profits, while keeping the bulk of your money safe.  Remember, it’s not how much you have, it’s how much you keep.

The goals for your gambling should be to have a fun time, keep your losses to a minimum, and hopefully, wake up in your own bed.  (And of course, if you do by some thin chance emerge with more money than the amount with which you started, take it and put it into secure investments.)  Like speculation, you should keep gambling to a small portion of the money you put into safer investments.  Unlike speculation, you should not hold any expectation that sliding quarters into a slot machine will return a great deal (or any) of your ‘investment’; remember, all those lovely casinos are built on the losses of you and other gamblers.

There is one final similarity between gambling and speculation: neither is necessary for your financial well-being.  Feel free to avoid both, as long as you also resist any urge to take more risk than needed with the rest of your portfolio.  Consider both gambling and speculation as safety valves, allowing you to vent your more ‘eager for a big win’ tendencies, provided that you maintain the bulk of your portfolio in secure, safe investments.

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