Driving back home after a day at the office, I stopped at a gas station. While filling my deposit, another guy placed his car at the next counter, stepped out of the vehicle, grabbed the pump, and while filling his car’s deposit I heard him complaining out loud. Probably he was doing so to me, as I was the only person around. With a grumpy voice he started:

-“These damn speculators! Gasoline just keeps going up! You know? They earn a lot of money from doing what they do, but my salary is just average. Very soon I won’t be able to afford a vacation anymore! Who knows at what price will it be next week, so now I have to fill my deposit just in case!.”

I didn’t reply. After he finished, he paid and left in the same manner as he arrived. But the event actually got me thinking. Was this man aware of what being a speculator means? Was he, after filling up his deposit in expectation of higher prices, actually acting like one?

In order to differentiate between speculation and investment, it would be useful to first address the meaning of these terms. I haven’t been able to find a more accurate, yet simpler definition of what investing actually means than the one provided by Benjamin Graham. It goes as far back as 1934, to his disruptive book Security Analysis:

“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

And he also added an additional criterion: “An investment operation is one that can be justified on both qualitative and quantitative grounds.”

Certainly, the safety of principal can only be assured, or most likely, expected, after any aspiring investor exercises due diligence. Put simply, it must put time and effort into analyzing the security at issue and ferret out those undervalued or expected to increase in value in the future. This analysis must be executed by well-established standards to be considered reliable. And it must cover both qualitative and quantitative grounds. That is, not only we must see that the financials of the company are strong enough or the current price fair, but its ability to generate profits over the long haul is quite promising. This dual analysis complements each other. That is how our investment will be considered safe and we could expect a return on it. And otherwise, it will automatically be considered speculation.

Mr. Graham did not like speculation as it represented the exact opposite of what he bruited around. He drew a straight line between both concepts and strongly encouraged everyone to stick to a proper analysis of the business. Nevertheless, if any person, wanted to “play”, he suggested to put a portion of your savings aside–as little as possible–and ‘bet’ on securities as pure gambling, under your own notion that, sooner than later, the money would evaporate. And never, ever, EVER, mingle both types of operations. Neither in your account nor in any part of your mind.

Nonetheless, he found the real distinction between the investor and the speculator in their attitude toward stock-price movements. The speculator, with the ultimate goal of profiting, would try to predict and take advantage of these movements. The investor, on the other hand, does not care about these movements. He would first try to find promising businesses with high value, and only then, go to the market and see whether the stock is selling for an attractive price. Only if the value of the business is above the market price… voilá! He just discovered a new investment opportunity. The market exists, therefore, to serve him and provide him with wonderful opportunities to profit.

Some other factors also influence how we perceive the speculator and the investor. The duration an individual holds the security is one of them. There are short-term investments when the conscious and methodical process described above takes place in just a few months, and there are long-term speculations when a purchaser holds a stock or a bond for longer than a year hoping to make up a loss. And the other way around.

Note that upon extreme economic periods (manias and crashes), collective experiences cause an effect and reshape how people act and think. For instance, the excessive optimism of investors at the heights of bull markets–the more extended, the greater this effect–fed by large gains and persistent triumphs, leads these individuals to miss the big picture and avoid rigorous analysis on securities. Why go after so much trouble if the next fellow will pay more for it, right? What eventually occurs is that the money they manage on behalf of retail investors, or themselves, become the primary food of the bubble monster.

Howard Marks says in his last book that “price doesn’t matter” is a basic ingredient of a market bubble. When you buy because you believe its price will simply go up, regardless of its actual value, and someone else will pay that new price for it, you may end up doing like that guy at the gas station. You may think that you are acting very smart, anticipating its higher price just to find the next week driving home that it has declined and that you could have saved a few bucks waiting a few days. Obviously, this particular real-life example is not of the utmost importance, but it is in fact when the value of those companies you own on your portfolio change dramatically.

On the other hand, especially after harsh times, the use of these concepts becomes sullied by bad experiences and the frustration of people. It is for this reason that stocks are commonly regarded as speculative after recessions, such as during the Great Depression that started in 1929, or at the time of my story, which took place right after the Great Financial Crisis. Stocks were recovering, but the blood was still in the streets.

Now take a moment to reflect about the current market environment. How do you see it? What kind of criteria use those around you to buy and sell stocks? The mere act of considering the psychology of the masses and how they put money in the market can give you a pretty good hint of the valuation of the stocks, as they are tightly correlated. And how they put money on the market is related to the rise of new financial technologies during the last couple of decades. Think for instance about the new popular Robinhood app, an online trading platform (OTP). You can easily open an account and in very short time start buying stocks. How do you think this affects the market? It hasn’t helped a bit. The quick, simple, and “convenient” access for young people anywhere at any time, the well-studied engaging user interface–adapted from games and social networks to create addiction–and the easy access to complex financial instruments–operating on margin–are blurring the line and minds of individuals even more. Add the pandemic situation, lockdowns, and a massive crowd of big-ego guys on social media boasting about the incredible stock performance of their portfolios and the very simple strategies they use, and what do we get? Stock valuations insanely overvalued by any historical standards.

I hope the reader is now more aware of not only the difference between these two concepts but also how to act accordingly. Your pocket and mental health depend on it. And if nevertheless, you want to risk too much of your capital at the expense of it, just remember the saying, as old as the Bible: “those who live by the sword might as well perish by the sword”.