What is the difference between investing and speculating?
In its simplest form, speculating is buying something with the hope that the price will go up.
Investing, on the other hand, is an activity that promises safety of principal and an adequate return. Let me explain this in real estate terms.
Speculative Home Purchase
I lost a significant amount of money on the speculative home that I had built with the other partners. Let’s examine why. First, you must realize that you cannot control the market, and it is very hard, if not impossible, to predict what the market is going to do.
The market has a psychology behind it. That psychology is the group psychology of the participating investors and speculators. After we built the house that had originally appraised for $1,250,000, the market turned quickly.
First, there was the jumbo loan crisis along with the sub-prime crash. This triggered more inventory to hit the market as everyone, all of a sudden, wanted out. This pushed prices down further and further as more inventory kept hitting the market with fewer and fewer buyers.
Speculative Home Purchase – Why did we lose money?
Did the market cause us to lose money? My feeling is no. It was our investment, or more accurately labeled, speculator strategy. You only lose money when you sell. The reason we lost money was because we sold. Why did we sell?
We were losing around $7000 a month in interest payments we were making on a house that was worth less and less every day.
Was this the right thing to do? Considering our circumstance, it was our only choice. We looked into renting the home, but the most we could get in rent was $4000 with most people quoting more like $2100.
We just couldn’t lock ourselves into a contract where we were losing $3000 or more every month.
Investing – Exactly What is It?
But let’s look at this from the beginning again. What if we had purchased 24 houses for $50,000 each and rented those out for $800 a month?
Let’s say our payments on the homes are $300 a month and property taxes and insurance are $200 a month. Now let’s assume that the market took a plunge, and the value of these houses dropped the same. Would you lose money?
No. Why would you even think about selling? You are making $7200 in cash flow every month after paying your payments, taxes and insurance. You would never think about selling something for a loss that is paying you money, especially $7200 a month. It doesn’t matter what the market is doing. You are still making money.
Difference Between Speculation & Investing?
This is the difference. The first case study is speculation, because if the market does not cooperate, you don’t make money, and as you have seen from this example, you can lose a lot of money.
The second scenario, which is what I did from that day forward, is investing. You are protecting your principal and ensuring an adequate return on your money. You must invest in income producing properties that have cash flow. To do anything else is pure speculation.
To speculate is to gamble. Can you make a lot of money speculating? Absolutely! Can you lose a lot? Yes, I know from experience. Choose investing!