“An investment allows for the prediction of future cash flows”
Are you an investor or a speculator? Do you know the difference? Many people differentiate the two via risk associated.
• Less risky, investment
• More risky, speculation
• Extremely risky, gambling
Sound familiar?
I prefer Buffett’s definition, “If you are an investor, you're looking at what the asset or business will do. If you're a speculator, you're primarily a forecaster on what the price will do – independently of the business.”
An investment allows for the prediction of future cash flows. Future cash flows are “what the business will do”. A speculation depends on selling the asset to someone else for more, which in essence is forecasting what the price will do.
Let’s take two examples:
I buy a piece of land and plan on building homes for sale. I project my future profits from the sale of the homes versus the investment in the land and construction of the homes. This is an investment. I have a plan to produce future cash flows from the business.
I buy a piece of land because it is in a “hot” area. I have no plan for the land other than to wait as it appreciates in value and flip it to someone else. This is a speculation. My entire return is based on an expectation of price improvement and selling to someone else.
Both examples used the same piece of land, the same asset. But how I approached them varied greatly. The difference was not marked by the risk or by the result. Option 1 could have ended terribly; it would have been a bad investment. Option 2 could have gone great; it would have been a successful speculation.
Personally, I do not speculate. I go into an investment with a plan to produce future cash flows. If I cannot figure out and project those cash flows, I do not invest. Speculation does not work well with my personality. I am not suited for it. In the end, this game is all about finding what works for each of us.
It is also important to note that investment and speculation are not always mutually exclusive. I may buy the piece of land, have a plan to build, and before I begin someone comes and offers me a great price to buy it. Was that an investment or speculation? It was an investment because I entered with the plan to produce the cash flows. I was not dependent on the buyer appearing for my thesis to work out.