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  4. Why you should speculate in the market (and how to)

Why you should speculate in the market (and how to)

Once upon a time, investing was easy because there were so few choices. Those days are long past – investing today is like being in a town fair. There are attractions all around and the temptations to make quick money are too many. Crypto assets, derivatives, IPO and pre-IPO investments are all clamouring for our attention. Even the boring debt markets have novel high-yield options today.

What is the investor to do?

speculate, benefits of speculation

Financial advisors will tell you to stay focused. There is a direct and clear path to wealth that is founded on the bedrock of allocating, balancing, diversifying, and cost-averaging one’s investments. 

But is that advice pragmatic? Even in life, it is pretty dull to live by the rule-book, never once deviating from the straight and the narrow. We live in an era of behavioral economics and finance. So should we have a more nuanced approach to what we consider acceptable in investing? 

I think so. Incorporating a measured dose of speculation into your investment activity is healthy for your mindset and your portfolio, in my opinion. I have done so myself and I am better for it.

Speculation must be like seasoning on a dish – a little bit goes a long way, and the sure fire way to ruin the taste for it, is to overdo it.

But there has to be a method to the madness. Speculation must be like seasoning on a dish – a little bit goes a long way, and the sure fire way to ruin the taste for it, is to overdo it.

What is speculation?

Before I defend my opinion, let me clarify what I mean by speculation. To me, speculating on investments should be a combination of these things:

  1. It should be short-term oriented. By short-term I mean, anything where you can see the results within 6 months. Investing in a micro-cap fund as part of your MF portfolio is not speculative in my mind. But betting on a stock to go up (or down) in a time-frame of 3-6 months would be speculative.
  2. It should involve a high-risk, high-reward bet. Speculation is about gaining returns that are significantly higher than those likely from high-risk but diversified vehicles  like sector funds. 
  3. It should be in reasonably liquid investments. If you are taking a  bet on something that can deliver in quick time or backfire, you should be able to enter and exit with ease and speed. A counterexample to this would be real estate – speculative real-estate investment is an oxymoron in my books for illiquidity.
  4. It should require some amount of skill and thought to carry out. I am putting this in here just to distinguish speculative “investments” from pure gambling. Buying a lottery ticket will satisfy 1, 2, and 3 above, but would we consider that as speculating in the market?

Investing in a ‘meme’ stock, rolling the dice on a crypto, trying your hand at options, taking a lark on an IPO – all these would constitute speculation for me – something in-between pure gambling and long-term investing.

Ring-fencing speculation

The most important guideline for speculating with your investments is, as doctors would say, ‘Do no harm’. Your core investments should carry on uninterrupted while you are playing in this sandbox of speculation. For this, you would need to effectively ring-fence your speculative investments from long-term investments.

You need to define two things for yourself: How much and where. My approach is to consider 5-10% of your overall financial investment portfolio value (not your net worth – only your market-linked investment portfolio) as your ‘allocation’ to speculative bets. Where you use this money would depend on where your understanding and interests lie.

The best thing to do would be to create a ‘spec sheet’ – a simple, short documentation – either on a piece of paper or Google doc – of how you plan to speculate. It should contain these two things:

  • an actual rupee amount (calculated as a percentage of your portfolio) of how much money you are willing to put at risk
  • what instruments you are going to invest in with the money. 

You can change this sheet as time goes, but as long as this document is there, it acts as a check on how you are going to speculate.

Benefits of speculation

The main benefit of engaging in measured speculative activity is that it allows us to exercise our animal spirits in a manner that does not harm our long-term interests – wealth creation through disciplined investing. We grant ourselves freedom – not unrestrained, but sufficient – to let us venture out of our comfort zones and try new things. It also gives us these other benefits:

  1. No mo’ FOMO – every time we hear our friend or colleague say that they scored big on some Dogecoin purchase or struck rich on an IPO, there is a twinge in our heart about the missed opportunity. When you have a kitty for speculative bets, you don’t have to miss out on these options, and can find something that you can brag about yourself!
  2. Satisfies need for action –  Prudent long-term investing requires long periods of inaction. But inaction is anathema to many of us and we would like to constantly be ‘doing’ something to get ahead. When we take a risky bet, our attention is focused on that disproportionate to the amount of impact that choice will have on our wealth. In my own retirement portfolio, filled to the brim with ETFs, diversified funds, and debt funds, I recently invested a small amount in a LEAP call and another in a meme stock. I tend to excitedly look at the value of these two holdings and completely ignore what is happening to the rest of the portfolio that is moving at a snail’s pace. And that is just great, because I’m not constantly watching and tinkering around with my core portfolio to get the ‘best’ return.
  3. A great learning opportunity – Nothing teaches you better about evaluating risks and the pain of losing money than when you bet your own shirt on it. No books, no knowledge bases, no mock trades – can really teach you what it feels like to be wrong or win big. When your money is at stake, you’ll read up all that needs to be understood about it. So, even if you lose all the money at stake (as you well might), you would be richer for the knowledge gained. You can apply this to your mainstream investments.  
  4. Knowing your true risk appetite – Many of us think of ourselves as risk-taking or very conservative investors. But it is our actions and not this perception that defines our true risk profile. When you get out of your comfort zone and take risks with your money, that is when you understand how you behave when the chips are down. It does not matter that the amount involved is (relatively) small – you care about it, and you are vested in its success. By observing how you behave as the market tosses your money around – you will learn more about yourself than any number of risk questionnaires you take. 

And, hey, you could score! – Sure, why not? You are investing in high-risk, high-return instruments, and if you get it right – by luck or skill – you could strike it rich. If you are savvy enough, you will know whether it was luck or skill that made you money. If it is the latter, you just found your tract of gold!

Dos and Don’ts

Speculating can be an addictive activity. So here are some cautionary notes:

  1. Take informed bets: Your high-risk activity should be informed speculation – not wild bets. That would be no different from betting on black on the roulette table. Plus, blind speculation will teach you nothing – whether you win or lose. So, if it is a meme stock, read up some DDs (deep-dives) on it before getting in. If it’s crypto, understand how mining works, the difference between ‘proof-of-work’ and ‘proof-of-stake’, environmental impact and such. If it’s options, then learn strategies. If you think of the speculative investment as tuition fees for a college, you will come out better regardless of the monetary outcome.
  2. Branch out – Try new products. Just don’t try riskier versions of products you are already familiar with. This gives you a better opportunity to learn things you didn’t know.
  3. Do NOT exceed the allotted amount – However well your speculation is paying off, stick to your boundaries. Else it can be a slippery slope. Whatever money you have allotted for speculation, keep to it. Don’t go all in with a YOLO trade. Just. Be. Careful.

However well your speculation is paying off, stick to your boundaries. Else it can be a slippery slope.

So, define what speculation means to you, and stay within the bounds. Use it as a learning opportunity, branch out, share your stories, and have fun!

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