Distinction between Investment and Speculation

Benjamin Graham, a famous investor in his own right and also notable because he is the man that taught Warren Buffett to invest, defined the difference between speculation and investment in this famous passage from his book The Intelligent Investor.

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

Note that investing, according to Graham, consists equally of three elements:

1. Thorough analysis - which means the study of the facts in the light of established standards of safety and value;
2. Safety Of Principal - which means protection against loss under all normal or reasonably likely conditions orvariations;
3. Adequate return - which means any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence;
   (Source: Security Analysis, 1934 Edition, by Benjamin Graham)
   

Like casino gambling or betting on the horses, speculating in the market can be exciting or even rewarding (if you happen to get lucky). But it’s the worst imaginable way to build your wealth. That’s because Wall Street, like Las Vegas or the racetrack, has calibrated the odds so that the house always prevails, in the end, against everyone who tries to beat the house at its own speculative game.

On the other hand, investing is a unique kind of casino—one where you cannot lose in the end, so long as you play only by the rules that put the odds squarely in your favor. People who invest make money for themselves; people who speculate make money for their brokers.

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell."

Benjamin Graham also say that to have a true investment there must be present a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience.