Exploring Speculative Investing
To trade (speculate) or not to trade is a difficult question faced by investors, especially when stocks tend to trade sideways for a longer duration than expected. Actually, what is better – to remain passively invested for the long term or to speculate on the basis of market directions and beat the markets to generate above average returns? Or should investors attempt to speculate and at the same time remain invested for the long term? Shreya Chaware explains one of the smartest ways to manage the dilemma
A majority of investors dabble in the stock market with their own unique philosophy and expectations. In fact, wrong expectations or rather overhyped expectations create some serious problems for beginners. However, after spending a good amount of time in the equity markets, most investors realign their investment goals and the strategies they wish to adopt, the focus of course being to maximise returns. The interesting fact is that even after spending several years in the equity markets and remaining invested for the long term, most investors are tempted to indulge in speculative activity for quick returns. The temptation for quick returns is huge and almost unavoidable.
Managing Speculative Investing
Several academic research studies have pointed to the benefits of remaining invested in the equity markets for the long term. However short-term speculative bets, if successful, can do wonders to the overall portfolio returns. It all depends on how much capital is employed for speculative investing purpose as against the amount deployed for long-term investment purpose. The chances of success in speculative investing can improve if the speculative investment portfolio is completely detached from the long-term investment portfolio. Often enough, the reason for failure in speculative investing and in long-term investing is the lack of clarity and inability to bifurcate both the portfolios.
Says Shirish Sonawane, who has been investing for the past 10 years, “Long-term investing is not as easy as it sounds simply because most investors overestimate their ability to remain invested during turbulent times. Short-term trading and investing (delivery-based) provides instant superior results if you understand the entry and exit levels. If you have a strategy in place and are a good observer of the market trends, speculative investing is a rewarding experience. This, however, does not imply that long-term investing is inferior or it can be ignored at the cost of short-term speculative investing. In pursuit of short-term gains I have missed opportunities to remain invested in multibagger stocks like Tata Elxsi and BSE.”
“I frequently traded in both these shares when I actually would have made more money by sitting on both these shares. At the same time, I made more money trading in Tata Motors and Tata Power than by holding it passively. Bajaj Auto, for example, is up by ~3 per cent in one year while I have booked at least 20 per cent trading in shares of Bajaj Auto in six months. It all depends how smartly you time the markets and whether you are a fast decision-maker to optimise speculative investment returns. I have divided my money into two different accounts. One is for pure long-term investments and the other is purely for speculative investment purpose where I simply bet on my instincts aided by my study and some professional advice. The goal is to not confuse trading portfolio with the investment portfolio and vice-versa,” he adds.
Indeed, it is important to keep both the portfolios separate and not mix them because it is seen that investors and traders trade in stocks that are originally meant for long-term investing and keep stocks for the long term that were originally meant for short-term trading. As such, losses are seen in most portfolios because of the lack of discipline by both traders and investors. The best way to manage this is to keep separate demat accounts for both activities. For speculative purposes, a minimum of 5 per cent capital should be allocated.
If the progress is good and if speculative investing is working well, one can always build on the capital and increase the concentration on speculative investments. While doing so it is important to also decide when to stop the speculative investment activity. An erosion of 50 per cent of the trading capital is just a point in case here, which can help an investor to decide to stop the speculative activity. The upside of prefixing a certain percentage of the portfolio for speculative purpose is that the risk is limited. By allocating not more than 5 per cent of the total capital to speculative investment purpose prevents investors from taking big risks and allowing the rest of the portfolio i.e. 95 per cent of the total capital to grow in compounded fashion over the long term.
Conclusion
Speculative investment is not good for someone who lacks trading skills and knowledge of technical analysis. For a skilled trader with a penchant to identify market trends, speculative investment can be a rewarding experience. The return on investment i.e. ROI can be unmatched if speculative or short-term investments are conducted with the help of a trading system and a proven strategy. In case any investor or trader wants to consider speculative investment as more than a hobby it is only advisable that formal training should be undertaken in order to improve the odds of winning. Also, for the skilled investor and trader, if the results of speculative investing are good, there is no reason to stop the activity.
Speculative Investing V/S Long-Term Investing
The level of risk undertaken is considerably higher in speculative investing when compared to long-term investing. While investors attempt to achieve satisfactory and steady returns over a long-term period by taking below average amount of risk, speculators seek abnormally high returns from bets that can go one way or the other. Speculative investing also involves use of derivatives instruments such as futures and options. Short selling is also commonly used by speculative investors, which is never practiced by long-term investors.
Another major difference between speculative investing and long-term investing is the amount of churning that happens and the transaction costs incurred. The transaction costs incurred by adopting speculative investing are considerably high while the tax component will also be higher in speculative gains. Any investor or trader willing to indulge in speculative investing needs to factor in the transactions costs and higher taxation before comparing the results with long-term investing.
In fact, it makes sense to shift some additional capital to speculative investing activity. Based on the results (performance) and confidence level which may vary month on month, a capital allocation strategy can be decided. The biggest risk of getting involved in speculative investment activity is the opportunity cost. Also, the possibility of losing 100 per cent of the capital can have a disturbing effect on an investor, leading to loss of confidence and poor judgement on the equity markets, which in time may impact the long-term portfolio construction activity. Unhealthy results in speculative activity may produce inferior results in the long-term investment portfolio as well.
Hence, speculative investment should be carried out with minimal capital while also ensuring that the risk capital is adequate to implement the desired market strategies and the absolute size of gains are large enough to justify the time and effort. Aggressive investors can allocate up to 20 per cent of the total capital to speculative investing activity, assuming the tricks of the trade are well-known by the investor. For the beginner with a low risk profile, up to 5 per cent of the total capital set aside for the equity market can be used for speculative bets. The trick is to know when to stop and when to keep the speculative investments going. If the market condition deteriorates or if a big macro event is looming large, usually it is best to stay away from any speculative bets. The investor himself is the best judge of what is a healthy mix (capital allocation) of speculative investments versus long-term investments. Avoiding one at the expense of another may lead to suboptimal performance of the portfolio