Christopher Steward, Director of Investments and Partner at Legacy Group Capital.
Speculative investment, or a short-term strategy to profit off a rapid change in an asset’s value, can be a high-risk move. Investors often resort to the practice during times of financial turmoil, such as new or changing regulations or an election cycle. Some take to the approach in an effort to earn a big return in a quick span of time to make up for any losses that the turmoil may cause.
Speculative investing relies on the hypothesis that someone else will value the asset enough to be willing to buy it for more than you once did—a theory so uncertain it’s known as “the greater fool theory.” So why would investors put themselves in the volatile position of losing earnings?
There’s one main reason: a potential for high returns. Speculation, if executed in a calculated manner, can produce solid results. But the approach is not repeatable. You may have gotten lucky on chasing the stocks of a cryptocurrency after a major revenue boom, and it may even continue to pay off if you hold onto those stocks for an extended period. However, you lose control of the situation and, potentially, your earnings if you go in on a speculative investment with no exit strategy.
Remember to build your base.
An investment portfolio can be broken down into two categories: Your long-term, or core, holdings and your short-term, or satellite, holdings. Your core holdings are something you use as a base and continue to build on when the market is down, such as the S&P index or real estate holdings. Your satellite holdings are strategic investments you’d like to cash out on soon, such as AI, nuclear energy or EV stocks.
When you sell your satellite holdings, especially early on, it’s typically recommended to put the bulk of your earnings toward your core holdings while the remaining cash can be used to secure a short-term, speculative investment once again. It could be wise to use a vehicle such as a Roth IRA to place your speculative earnings in, as you can generate capital in a tax-free manner.
Limit your risk of losses.
Especially for early investors, it’s important to consider two factors: your risk tolerance and your potential loss exposure.
If you have only been investing your earnings for a few years, and especially if you are still building out your core holdings, you may not be comfortable with the value of your speculative investments fluctuating (let alone fluctuating widely). If you’re a long-term investor with a capital cushion and an innate understanding of the market, you may be willing to tolerate a little bit more.
But what percentage of your earnings could be lost if your speculation, or your hunch, is bad? The temptation is to neglect one’s core holdings to follow the next satellite trend, throwing all the chips on the table with the dream of hitting it big. It’s just as likely, if not more likely, that those chips will disappear. The wisdom in the strategy is knowing when to take them off the table.
Everyone, regardless of economic standing, has one investment objective: to earn enough money that you can accomplish the goals you have for your life. A young person may start investing to build their profits to buy a house to raise children in. A middle-aged person may continue investing to set money aside for their child’s wedding so they can start their marriage debt-free.
Despite the way financial goals may differ from one person to the next, directionally we all want the same thing: to be making money and not losing it. That’s why limiting your potential of loss to a figure that won’t devastate your earnings is vital. This can be done by putting the lion’s share of your investment profits into your core holdings, even if they do take years, rather than months, to show their growth. Then, put a smaller percentage of your discretionary funds into speculative investments.
Don’t go in without a plan.
If you’re looking for a key takeaway, this is it: Speculative investment isn’t all bad, but it can be if you go in without a plan. The idea of being a part of the development of the next Facebook is thrilling, but the idea of losing your “rainy day” fund due to a swing-and-miss of a suspected success is much less so.
When thought out, speculating can help build on an existing, diverse portfolio that provides long-term returns over a more stable timeline. Like the Athletics in their Moneyball era, you’re hedging a bet on what’s going to make you money quickly. Just know your take on investment sabermetrics might not offer you a profit margin comparable to the likes of Scott Hatteberg.
This is not considered legal advice. Please talk to a qualified accountant about this or any other strategic investment strategies before moving forward with them.
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