Last week I wrote about where to begin with investing. Starting with putting money into the stock market for the purposes of saving for retirement is where I recommended most people start. It allows for people to dip their toes in the water and build confidence with investing. However, some of us want to have a little fun with investing, which is what this post is all about! How do we do that? Speculative investing.
Recently there has been an uptick in discussion around speculative investing. Individuals on the discussion website Reddit have banned together to move money away from large hedge funds to every-day individuals. Basically what these individuals are promoting is a version of day-trading, which I’ll talk about more in this article; however, before I dive into 4 types of speculative investing, it would be irresponsible for me to not mention the following pieces of caution.
Speculative Investing is NOT a Requirement to Build Wealth
Speculative investing is not a requirement to build wealth. That statement is so important that I wanted to rewrite it from the header of this section! You can invest in index funds, mutual funds, and managed investment portfolios, and build wealth. Those investment types are the core of any strong investing portfolio.
If speculative investing does not hold any interest for you, then don’t feel compelled by this article or any other source of information that you need to engage in speculative investing, because you don’t!
Speculative Investing is Like Gambling
Speculative investing is as risky as it can get when it comes to investing! While there could be high reward, there is likely more chance of losing money when it comes to speculative investing. If you choose to conduct speculative investing, it can only be after you have already put into place methods to save safely for retirement, have a funded emergency fund, and are working towards other goals.
Speculative investing is for fun, but we cannot risk our home, our retirement, or any other part of our well-being because we took too much risk. If you want to engage in speculative investing, only invest an amount you are willing to lose completely.
Be realistic with your expectations. After wallstreetbets took off recently, people posted about how they were able to pay off their hundreds of thousands of debt, buy a new home with cash, or that they became much more wealthy overnight. That is not realistic. It is important to keep your expectations in check. What happened with that movement was unprecedented and the people who got in early just happened to be in the right place at the right time. Many more individuals likely bought at a high and are now holding stock not worth near what they paid for it.
Also, if you are investing an amount that won’t break the bank or put your financial future in jeopardy, it likely also won’t make you a millionaire overnight. It’s fun to have a goal in mind, but knowing an astronomical return is not guaranteed simply because you’re taking risk is critical to keeping perspective.
Timing the Market Correctly is Impossible
The goal for investing is to buy low and sell high. The research says that we humans do the exact opposite. We buy high and sell low. We are overconfident in our ability to select and time the market and we are too emotional to sell at an appropriate time.
If you choose to engage in speculative investing, know that you will never make all of the choices correctly. If you do, it is actually an accident and you cannot rely on the fact that you will be able to do it again. Simply knowing that you can’t time the market perfectly is an important mindset to take into speculative trading, so you aren’t always saying “well, if” or “if only I would have…”
Paying Tax on Speculative Investing
Investing is not like a paycheck, most brokerage companies do not withhold taxes when you take money out of a brokerage account. So, it’s critical to ensure you are aware of the tax you will pay on the profits you make (i.e. capital gains). Even if you sell the investment, but don’t take the funds out of your brokerage account (unless it is in a tax-deferred retirement account) there is a taxable event.
If you buy and sell a stock within the same year and make a profit, it is called a short-term capital gain. This gain is taxed as income. So, it’s critical to know how much profit you are making and what your marginal tax rate is. If you make profits, next April (or June, or July – who knows what the future holds after the last two years!) Uncle Sam is going to come calling for that percentage of your investment profits.
If you buy a stock and hold it for one year or more and make a gain on it, then it’s called a long-term capital gain. You will be taxed on these gains based on your taxable income amount. For most people that are engaging in speculative investing, this is probably a rate of 15%. Below is the full table of long-term capital gains tax rates:
|Taxable Income by Filing Type
|Married Filing Separate
|Head of Household
|Married Filing Jointly
|Up to $40,400
|Up to $40,400
|Up to $54,100
|Up to $80,800
|$40,401 to $445,850
|$40,401 to $250,800
|$54,101 to $473,750
|$80,801 to $501,600
An Introduction to 4 Types of Speculative Investing
There are four types of speculative investing in the stock market that I’m going to cover in this post. First, I pick these four because they are through the stock market, speculative investing like in real estate, collectibles (art or cars for example) and currency (gold or cryptocurrencies) are done through different ways than through brokerage accounts and brokerage firms. Also, I have a pretty great understanding of these four ways to invest speculatively because I’ve audited each of these trading forms.
Day trading is a form of active trading, where you invest in stocks for a short period of time (typically less than a day – why it’s called day trading). The point of day trading is to do volume trading, and not necessarily make a significant amount of money on any one trade alone.
Day trading is about trying to time when a stock is low (the trough), buying it, then watching the stock go up to a high (the peak) and then selling it. You can do this in one stock over and over again based on it’s cycle of movement or use different stocks.
This type of trading is time intensive and it takes a lot of diligence to choose the right stocks that are at a low but are going to rebound to a high. It also takes a lot of emotional control and not obsessing about what the true bottom or peak are. While profits may not be large (5 to 10 cents a share), if you are actively trading profits can add up over time.
For day trading to be successful, it is critical to use a brokerage firm that doesn’t charge high commissions on this type of trading activity. Even a $7 trade commission can greatly impact the return made in this type of investing. Day trading is something you can choose to do for a few days here and there, and when you aren’t able to watch, have the funds in a money market account.
When a company chooses to go from privately held to publicly traded, it can do it in many ways. The most common is through an Initial Public Offering (IPO). An IPO generally means that a company is issuing ownership (i.e. stock) to the public in order to raise capital for the business to pay down debt or use to grow the business.
IPO Investing is buying shares prior to the company trading on the open stock market. A company is given a valuation by an underwriter and an IPO share price is set for the company. To invest in IPOs, you must have an account open with an underwriter on the IPO, have funds sitting in the account, and request IPO Shares. There is typically a questionnaire that you have to fill out. Then you have to be chosen by the underwriter to be distributed IPO Shares. I say all of this to point out the complexity of investing in IPOs and that it is also sometimes the luck of the draw to be selected to be distributed shares.
I’ll give a couple of IPO examples, though, to demonstrate that there is money in this. LegalZoom (NASDAQ:LZ) went public on July 1. IPO shares were distributed at a price of $28. When shares started trading on the open market, the trading price was $38.50. That’s $10.50 per share profit. It’s still trading at between $35-$38 per share.
Cricut Inc (NASDAQ:CRCT) is another company that has gone public in 2021 through an IPO. It’s IPO price per share was at $20. However, when it started trading on the open market it started trading below that price. It has since rebounded to trading at around $37-$38 per share. That’s $17 to $18 of profit per share.
Why is IPO trading considered speculative investing? Well, these are two of many companies that have gone public in 2021. Many are trading below the IPO share price, and the value of shares can be extremely volatile for up to the first year. In the first year a lot of insiders are liquidating positions and investors (aka the street) are really making up their minds on the value of the company.
Being aware of when IPOs are happening and being able to discern the interest in investing in a certain company are keys to IPO investing. Also, choosing an endgame to IPO investing is critical. Are you buying the shares long-term because you believe in the company? Or are you wanting to make a quick buck, more like day-trading, and don’t want to hold the shares?
Options are complex and only for sophisticated investors with a good amount (at least $50,000) of liquid assets (i.e. not your home or retirement funds). I put this behind the first two speculative investment options I’m covering, because it is not a place to start with speculative investing.
It is so complex that brokerage firms actually have to do additional diligence on an individual in order to allow options trading. Many firms choose not to allow options trading through their firm simply because of the additional risk it brings to the firm in terms of their supervision requirements. If all of that is enough caution that this isn’t where you want to start with speculative investing, head on to the next section.
There are two forms of options trades: a call option or a put option. Important to both of these is the term “strike price,” which is a certain price per share in the stock. It’s purpose will be clear as I describe call and put options.
A call option means you are buying the right to tell another person who owns shares of a stock to give them to you at a strike price (this strike price is higher than what the stock is currently trading at). This gives you the ability to watch what the stock does, and you only call them to you if the stock goes above the strike price. You only have to pay the strike price for the shares, so your upside potential is whatever the stock is able to go to above the strike price. Also, because you don’t own the shares, if the stock goes down you don’t lose anything (except for the price of the call option contract). So, your liability is limited.
A put option means you are buying the right to put your shares onto someone else at a predetermined price or the strike price (this price will be lower than the current trading price). This allows you to lock in a certain profit amount and if shares fall below the strike price, then you put your shares on someone else. This allows you to lock in the most value for the shares you have.
These two descriptions are the most basic forms of options trading. To engage in options trading you must have an account and be approved for options trading, which requires experience and an asset level as discussed above. Options trading is one of the more conceptual trading activities, as it is called a derivative contract, so you have to be confident in your understanding of this fringe type of investing.
Ok, so margin trading is not actually in and of itself a speculative investment type. It has to do with how you fund your investment activity. I include it as highly speculative, because you can easily get yourself into financial trouble if you use too much margin or use the money to invest in speculative investments that make no return overall over time. If you’re really into speculative investing, though, knowing about margin is an important tool. There are ways to use it to give you more cash to invest, which means the opportunity to make more money.
How it works is that you put cash into a brokerage account. You then use that money as collateral to take out a loan from your brokerage firm. You then invest your cash and the money loaned to you by the brokerage firm. You pay ongoing interest to the brokerage firm until you pay back the loan.
Current margin rates range between 3% and 12%, most hovering in the 6% to 7% range. Important to know is that historical market rates are around 8%. So, anything at our around that number for a margin interest rate is taking a huge risk. However, the markets this past year did great, so taking out a margin loan, if timed right could have been lucrative for many. However, in the wrong market and with the wrong securities, it is a losers game.
So, that puts using margin on my list of ways to take risk in the stock market. It can give you more cash to invest, but there is a huge amount of risk with respect to being able to cover the interest rate on the loan and make money.
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