While it is difficult to draw the line of distinction between investment and speculation, it is possible to broadly distinguish the characteristics of an investor from those of a speculator as follows.
An investor has a relatively longer planning horizon. His holding period is usually at least one year.
A speculator has a very short planning horizon. His holding may be a few days to a few months.
An investor is normally not willing to assume more than moderate risk. Rarely does he knowingly assume high risk.
A speculator is ordinarily willing to assume high risk.
An investor usually seeks a modest rate of return which is commensurate with the limited risk assumed by him.
A speculator looks for a high rate of return in exchange for the high risk borne by him.
Basis for decisions:
An investor attaches greater significance to fundamental factors and attempts a careful evaluation of the prospects of the firm.
A speculator relies more on hearsay, technical charts, and market psychology.
Typically an investor uses his own funds and eschews borrowed funds.
A speculator normally resorts to borrowings, which can be very substantial, to supplement his personal resources.
Gambling is fundamentally different from speculation and investment in the following respects:
1) Compared to investment and speculation, the result of gambling is known more quickly. The outcome of a roll of dice or the turn of a card is known almost immediately.
2) Rational people gamble for fun, not for income.
3) Gambling does not involve a bet on an economic activity. It is based on risk that is created artificially.
4) Gambling creates risk without providing any commensurate economic return.
Investment management (or portfolio management) is a complex activity which may be broken down into the following steps:
1) Specification of Investment objectives and constraints: The typical objectives sought by investors are current income, capital appreciation, and safety of principal. The relative importance of these objectives should be specified. Further, the constraints arising from liquidity, time horizon, tax, and special circumstances must be identified.
2) Choice of the Asst Mix: The most important decision is portfolio management is the asset mix decision. Very broadly, this is concerned with the proportions of stocks (equity shares and units / shares of equity oriented mutual funds) and bonds (fixed income investment vehicles in general) in the portfolio. The appropriate stock bond mix depends mainly on the risk tolerance and investment horizon of the investor.
3) Formulation of portfolio Strategy: Once a certain asset mix is chosen, an appropriate portfolio strategy has to be hammered out. Two broad choices are available: an active portfolio strategy or a passive portfolio strategy. An active portfolio strategy strives to earn superior risk adjusted returns by resorting to market timing, or sector rotation, or security selection, or some combination of these. A passive portfolio strategy, on the other hand, involves holding a broadly diversified portfolio and maintaining a pre-determined level of risk exposure.
4) Selection of Securities: Generally, investors pursue an active stance with respect to security selection. For stock selection, investors commonly go by fundamental analysis and or technical analysis. The factors that are considered in selecting bonds (or fixed income instruments) are yield to maturity, credit rating, ,term to maturity, tax shelter, and liquidity
5) Portfolio Execution: This is phase of portfolio management which is concerned with implementing the portfolio plan by buying and / or selling specified securities in given amounts. Though often glossed over in portfolio management discussions, this is an important practical step that has a bearing on investment results.
6) Portfolio Revision: The value of a portfolio as well as its composition – the relative proportions of stock and bond components may change as stocks and bonds fluctuate. Of course, the fluctuation in stocks is often the dominant factor underlying this change. In response to such changes, periodic rebalancing of the portfolio is required. This primarily involves a shift from stocks to, bonds or vice versa. In addition, it may call for sector rotation as well as security switches.
7) Performance Evaluation: The performance of a portfolio should be evaluated periodically. The key dimensions of portfolio performance evaluation are risk and return and the key issue is whether the portfolio return is commensurate with its risk exposure. Such a review may provide useful feedback to improve the quality of the portfolio management process on a continuing basis.