Investment, Speculation and Gambling

Financial and Economic Meaning of Investment

Financial Investments are the allocation of monetary resources ranging from risk-free to risky investments and with the expectation of a good return that varies with risk. The investor has to aim at a trade-off between risk and return. The investors are the suppliers of ‘capital’ and in their view, investment is a commitment of a person’s funds to derive future income in the form of interest, dividends, rent, premiums, pension benefits or the appreciation of the value of their principal capital. To the financial investor, it is not important whether money is invested for a productive use or for the purchase of secondhand instruments such as existing shares and stocks listed on the stock exchanges. Most investments are considered to be transfers of financial assets from one person to another.

The economist understands the term ‘Investment’ as net additions to the economy’s  capital stock which consists of goods and services that are used in the production of other goods and services. For them, the term investment implies the formation of new and productive capital in the form of new construction, new producers’ durable equipment such as plant and equipment, including inventories and human capital.

The financial and economic meaning of investment cannot be separated because the term draws a relationship with the economists and financial experts. Investment is a part of the savings of individuals which flow into the capital market either directly or through institutions; they may be divided in ‘new’ or ‘secondhand’ capital financing. Investors as ‘suppliers’ and ‘investor as ‘users’ of long-term funds find a meeting place in the market.

In this book, however, investment is used in its ‘financial sense’ and investment will include those instruments and institutional media into which savings are placed.

Investment and Speculation

Investment is distinguished from speculation in three ways which are based on the factors of risk, time period and gains.

1. Risk

The term ‘risk’ has significance in the financial meaning of investment. Whatever amount is invested has the probability of incurring a gain or a loss in a financial transaction. Investment is not considered to involve high risk but it has limited risk and risk can be calculated through different techniques and the capital can be invested in avenues where the principal is safe. ‘Speculation’ is correlated with ‘high risk’ and short commitment. There are degrees of risk, and arbitrary judgements are made between high risk and low risk. An investor cannot have completely risk-free investments because there are certain non-controllable risks that cannot be calculated. The purchasing power  risk or the fall in the real value of the interest and principal is beyond the control of a person. The money rate risk or the fall in market value, with the rise in interest rates also cannot be controlled.

These risks affect both the speculator and the investor. High risk and low risk are, therefore, general indicators to help an understanding between the terms investment and speculation.

2. Capital Gain

Speculation is buying low and selling high in a short time to make large capital gains. The motive in speculation is primarily to achieve profits through price changes. This can be distinguished from investment where securities are purchased by an investor through proper evaluation, analysis and review with the view of receiving a stable return over a long-term period of time.

3. Time

Time period explains the difference between  investment  and speculation. A fund allocation over a long-term period is called investment. A short-term holding is associated with trading for the ‘quick turn’ and is called speculation. The speculator is not interested in holding a security for current  income but for high short-term gains.

The distinctions between investment and speculation help to identify the role of the investor and speculator. To summarize the above discussion:

1.      The investor constantly evaluates the worth of a security through fundamental analysis, whereas the speculator is interested in market action and price movement.

2.      There is a very fine line of division between investment and speculation. There are no established rules and laws that identify securities which are permanently for investment. There has to be a constant review of securities to find out whether it is a suitable investment for long-term or for quick turn of speculative profit. Long-term commitment becomes investment of the same security which if sold immediately on purchase only for profit becomes speculation.

3.      Some financial experts have called investment ‘a well grounded and carefully planned speculation’, or good investment is a successful speculation. Speculation is planned short- term investment based on haunches and beliefs. Investment is planned, evaluated and analyzed long-term commitment of funds.

4.      Speculation is to achieve high returns though risk of loss is high. Investments are for minimizing risk of investors with the expectation of high returns. Therefore, investment and speculation are a planning of risks.

5.      A speculator expects high return for his investment and to make gains, he can commit his own funds as well as use borrowed funds. An investor is cautious by nature and usually uses his own funds for investing in securities.

The distinction between investment and speculation is given in Table 1.1.

Table 1.1: Distinction between Investment and Speculation

	Investment	Speculation
Time Horizon	Long-term time framework beyond 12 months.	Short-term planning holding assets even for one day.
Risk	It has limited risk.	High Returns though risk of loss is high.
Return	It is consistent and moderate over a long period.	There are high profits and gains as well as high losses. It is not consistent.
Use of funds	The investor uses his own funds through savings.	Speculation is through own and borrowed funds.
Decisions	Safety, liquidity, profitability and stability considerations and performance of companies.	Market behavior information, judgments on movement in the stock market, haunches and beliefs.

Investment and Gambling

Gambling is artificial and unnecessary risk created for increased expected  returns.  The difference between investment and gambling is very clear. From the above discussion, it is established that investment is an attempt to carefully plan, evaluate and allocate funds in various investment outlets which offers safety of principal, moderate and continuous returns and long-term commitment.

Gambling is quite the opposite of investment. It connotes high risk and the expectation of high returns. It consists of uncertainty and high stakes for thrill and excitement. Typical examples of gambling are horse racing, game of cards, lottery, etc. Gambling is based on tips, rumors and haunches. It is unplanned, non-scientific and without knowledge of the exact nature of risk.

The distinctions between investment, speculation and gambling give us a basic idea of their nature, purpose and role.

Investment and Arbitrage

Investment is planned commitment of funds from a person’s savings into different outlets with  the expectation of safe, stable and fare return. Arbitrage is the mechanism of minimizing risk through hedging and taking advantage of price differences in different markets. An arbitrage transaction is the simultaneous purchase of the same or similar  security in two  different markets. Short-term gains can be expected through such transactions. An investor can also be an arbitrageur if he buys and sells securities in more than one stock exchange to take advantage of the price differentials in such exchanges. Derivatives introduced in the Indian market have a great potential for arbitrage transactions. Arbitrage transactions help in enhancing efficiency and liquidity in the stock market and in increasing the volume of trade. Hedgers, speculators and arbitrageurs can minimize risks and  make  profits through the arbitrage process.

         TYPES OF REAL AND FINANCIAL ASSETS

Real assets are tangible goods in possession of a person. Financial securities represent papers that are dependent on real assets for creating wealth.

1.  Real Assets

Real assets are used to produce goods or services. They are tangible assets that have a physical form. Some examples of real assets are land and buildings, furniture, gold, silver, diamonds or artifacts. They may be marketable or non-marketable. They may also have the feature of being moveable or non-moveable.

2.  Financial Assets

Financial assets are called paper securities. Some examples of these assets are shares, bonds, debentures, bills, loans, lease, derivatives and fixed deposits. Financial assets represent a claim by securities, on the income generated by real assets of some other parties. Such assets can be easily  traded, as they are marketable and transferable. Financial assets are transactions between two or more parties. For example, if a person takes an insurance policy of ` 1,00,000 of Life Insurance Corporation, the contract is a liability of LIC but an asset of the person insuring himself because he has a claim over the insurance company to receive the principal sum with  interest  on the happening of an event or on  the completion of a certain number of years.

Table 1.2: Distinction between Real and Financial Assets

Real Assets	Financial Assets
Land and building, furniture and machinery.	Shares,    debentures,    bonds,    derivatives,                 fixed deposits, bills and loans.
Tangible assets moveable, immoveable, marketable and non-marketable.	These are called paper securities as they deal with claims generated on the issuer.
Theses assets are used for production of goods and services.	These assets are financial claims represented by securities.

3.  Commodity Assets

Commodities are a new form of investment in India. Examples of commodity assets are wheat, sugar, potatoes, rubber, coffee and other grains. Commodities are also in the form of metal like gold, silver, aluminum and copper. Cotton, crude oil and foreign currency are other examples of commodities. Importers and exporters invest in commodities to diversify their portfolios. Traders hedge or transact in commodities to make gains. A National Commodity and Derivatives Exchange Ltd. (NCDEX) has been set up in India in 2003 as a public limited company to transact in  commodities.

The promoters of NCDEX were ICICI Bank Ltd., National Bank for Agriculture and Rural Development (NABARD), Life Insurance Corporation of India, Punjab National Bank, Canara Bank, CRISIL Ltd., Indian Farmers Fertilizer Cooperative Ltd. (IFFCO) and National Stock Exchange of India Ltd. (NSE). All these institutions subscribed to the equity shares of NCDEX.

The above explanations of the terms of investment have provided a background to the meaning of investment. This chapter now presents the importance of investments, opportunities conducive to investment, media available for investment, investment features and the process of investment