Speculation is a financial term that covers financial action without the promise of safety for any profits or even the security of the initial investment. Speculation is considered an act of high risk investing in the hopes of receiving a high reward. Typically, most investors will insure their speculations with safer investments to offset any potential financial loss that may result.
Speculation often employs the lending of money to high risk groups with the promise of an extremely high rate of return upon success. Below are some examples of investments that are considered speculation:
1. Providing loans or financial support to a start-up or newly restructured business, in the hopes of growing the business into a profitable enterprise.
2. Investing in junk bonds or high yield bonds, which are very low rated financial instruments that will pay high return rates if they do not go into default.
3. Investment in highly volatile commodities, such as precious metals, natural gas and oil, and grains.
4. Investing in stocks with the plan of selling immediately upon a raise in value.
Speculation and investment are often considered two different forms of profit seeking. True investors attempt to safely use their financial resources to grow value over a long period of time. Speculators, on the other hand, typically have the goal of receiving a high reward in a short period of time, at the risk of losing their initial investment.
Just like investing professionals, many speculation professionals diversify their holdings to hedge against the uncertainty of the area they are in. Some risks of speculation are as follows:
1. Financial bubbles can be created when speculators inflate the value of a commodity or financial instrument above what the real price should be. When this occurs, the bubble will often pop, resulting in a drastic loss of value.
2. Investment in start-ups or small businesses may result in complete loss of initial investment if the business fails.
3. Speculation in high-default financial instruments will, by definition, fail to return value than safer financial instruments. While returns can be high on successful high default bonds, many more bonds will fail and result in loss of initial investment.
As with all investment strategies, you must be aware of the tax consequences of speculation. While speculation can result in large profits over a short period of time, these profits will be taxed at a higher rate than slower-growing investments. Any investments that yield a realized return in less than a year will be taxed at the standard income rate. Longer held speculative financial investments will be taxed at a lower rate, however this will often offset the value of speculation.