Why Speculative Investments May Not Be The Way Forward

Speculative investments can feel like a great way to make money. After all, price swings are wide so that it can feel like a small amount of money can result in significant gains — as long as you get in at the right time. However, it's important to understand the risks of speculative investment and how it can cause problems in your portfolio. Let's look at speculative investments and how they can potentially impact your portfolio.

Takeaways

• Examples of painful speculation gone wrong

• Assets you can use to speculate

• Current assets which are driven by speculation

What Are Speculative Investments?

A speculative investment includes something that has wide price swings, and that might not necessarily have strong fundamentals to underpin it. The idea behind putting your money in a speculative investment is the expectation that the price will head higher and that you'll be able to take advantage of that.

In many cases, a speculative investment is something that you think might go higher in price. Prices start low and then rise, potentially resulting in profits.

However, what makes it speculative is that the nature of the investment means that returns are less certain. These investments come with a higher degree of risk. You might be able to make it big by getting in at the right time, but you might also lose your capital if the investment does not pan out.

When deciding on a speculative investment, it's important to understand that it's more about the price and less about any underlying support for that price. Sentiment and hype are usually the main drivers of speculative investments.

Examples Of Speculative Investments

Throughout history, there have been different fads for speculative investments. Here are some examples of various speculative investments.

Tulip Bulbs

One of the most famous examples of speculation was that of tulip bulbs in the 1600s. When it became known that tulips could be grown from bulbs faster than seeds, a trade in bulbs picked up. Prices skyrocketed. Many investors speculated on tulips, buying up bulbs and hoping to sell them later for much higher prices.

Because enough people wanted to get rich, prices were very high by 1634. However, by 1637 and 1638, prices had dropped and leveled off. Those who were fortunate enough to buy before the craze could make lots of money, while those who purchased after the peak in prices were likely to lose money as prices fell.

Commodity Futures

Today, some people speculate on commodity futures, trying to guess which way the price will go in the coming months. But, unfortunately, there is no real way to say which way a price will go — or how far it will rise or fall.

What makes commodity futures potentially profitable is that you can use a high degree of leverage. So, you can put a relatively small amount of money down and borrow the rest to make your bet.

However, it's important to note that futures are contracts that represent an obligation. Options don't require you to go through with the purchase (although options are also often considered speculative). On the other hand, Futures require the contract holder to complete the transaction.

When you speculate using commodity futures, you have the potential to amplify your losses as well as your gains.

Cryptocurrencies

The most prominent example of modern speculation is cryptocurrencies and other digital assets, like non-fungible tokens (NFTs). Prices swings can be huge from day to day, depending on how interested people are in buying or selling a specific token.

Additionally, it's a new asset class. So it's challenging to determine what some of the underlying fundamentals might be. Also, because crypto assets are so new, some of the coins and NFTs introduced might not have long-term staying power. So you might be able to buy some tokens for a relatively small amount of money, but not all of them will make it big.

A good example was Dogecoin in 2021. With celebrities hyping it, many people bought into it, hoping to make it big. As excitement grew, the price rose as more investors tried to buy it and take advantage. Dogecoin started as a joke. It doesn't have much utility, even though some outlets accept it. After a couple of months of frenzy, the price dropped dramatically. Those who bought in at higher levels lost money and haven't recovered it.

While crypto enthusiasts expect blockchain technology to power the next phase of the internet and insist that cryptocurrencies have fundamentals, the reality is that it's hard to tell which cryptos will emerge as top picks, and which of the more than 10,000 coins will never make money for investors.

Plus, there's regulatory risk involved. For example, what happens if governments clamp down on crypto? What happens if governments issue their official digital currencies that use the blockchain?

Do Speculative Investments Have A Place In Your Portfolio?

For the most part, savvy investors only add speculative investments after covering their other bases. Before speculating, it's important to make sure your other stock portfolio goals and needs are taken care of.

Choosing value stocks or index investments can make sense to build the bulk of your ETF portfolio and reach your long-term goals. These investments have a track record, and they also have established fundamentals that you can consider.

Some investors like having a little "play" money for speculative investments. This allows them to potentially capture growth from new asset classes or add diversity to their portfolios. However, if you decide to use speculative investments, it's crucial to avoid risking more money than you can afford to lose.

Conclusion

Speculative investing can provide significant gains for investors who get in early and then sell as the asset's price approaches its peak. However, this approach can be research-intensive, and there's no real way to know which part of the cycle you're getting in on. As a result, using other investments to meet your goals might make more sense and reserve a relatively small portion of your portfolio for speculative experiments.