What Is the Difference between Investing and Speculation?

Categories: Philosophy
Robert Hagstrom, CFA

Editor’s note: Today, we are doing something different. Robert approached us with a question that we found interesting, so we decided to pose it to some professional investors. In addition to our regular coverage, we are pleased to feature his framing of an interesting debate. We will be publishing select responses to the question over the next few days. If you are compelled, we invite you to comment below, tweet us @cfainvestored, or reach out to us via email.

What is the difference between investing and speculation? At first, you think the answer is simple because the distinction is obvious — that is, until you actually put pen to paper and try to answer the question.

Go ahead; take a few seconds and think about it. Write down “investing.” Now write the definition. Do the same for “speculation.” If you are like me, frustration quickly builds because the answers do not come quickly or easily, and they should. After all, these terms have been a part of the financial lexicon since Joseph de la Vega wrote Confusion of Confusions in 1688, the oldest book ever written on the stock exchange business. In his famous dialogues, de la Vega observed three classes of men. The princes of business, called “financial lords,” were the wealthy investors. The merchants, the occasional speculators, were the second class. The last class was called the “persistent speculators” or the “gamblers.”

Since the Dutch shipping firm Vereenigde Oost-Indische became the first company to trade its shares on the Amsterdam Stock Exchange, investors and speculators have coexisted in the marketplace. Over that 400-year time period, the noteworthy have offered their own definitions of investing and speculation. But none have stuck.

Philip Carret, who wrote The Art of Speculation (1930), believed “motive” was the test for determining the difference between investment and speculation. “The man who bought United States Steel at 60 in 1915 in anticipation of selling at a profit is a speculator. . . . On the other hand, the gentleman who bought American Telephone at 95 in 1921 to enjoy the dividend return of better than 8% is an investor.” Carret connected the investor to the economics of the business and the speculator to price. “Speculation,” wrote Carret, “may be defined as the purchase or sale of securities or commodities in expectation of profiting by fluctuations in their prices.”

Benjamin Graham, along with David Dodd, attempted a precise definition of investing and speculation in their seminal work Security Analysis (1934). “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” Despite being the “dean of security analysis,” Graham’s definition left readers wanting more — a fact he confessed years later when he wrote The Intelligent Investor (1949). “While we have clung tenaciously to this definition,” said Graham, “it is worthwhile noting the radical changes that have occurred in the use of the term ‘investor’ during this period.”

Graham was concerned that the term “investor” was now being applied ubiquitously to anyone and everyone who participated in the stock market. He explained: “The newspaper employed the word ‘investor’ in these instances because, in the easy language of Wall Street, everyone who buys or sells a security has become an investor, regardless of what he buys, or for what purpose, or at what price, or whether for cash or on margin.” Graham went on to say: “Since there is no single definition of investment in general acceptance, authorities have the right to define it pretty much as they please. Many of them deny that there is any useful or dependable difference between the concepts of investment and of speculation. We think this skepticism is unnecessary and harmful. It is injurious because it lends encouragement to the innate leaning of many people toward the excitement and hazards of stock-market speculation.”

John Maynard Keynes, best known as one of the founders of modern macroeconomics and thought to be the most influential economist of the 20th century, was also a skilled buyer and seller of stocks, bonds, commodities, and currencies. In addition to thinking about economics, he was intrigued with the stock market. Tucked inside his magnum opus, The General Theory of Employment, Interest, and Money (1936), is a chapter titled “The State of Long Term Expectation.” Here, Keynes got right to the point, deciding to “appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise [a word he used for investment] for the activity of forecasting the prospective yield of assets over their whole life.” But the breadth of the chapter has less to do with the difficulty of defining investment and speculation and more to do with the observation that the lines between the two approaches had blurred. It is the same point that is driven home 75 years later in The Clash of the Cultures: Investment vs. Speculation (2012). In his book, John Bogle argued that in the minds of most individuals, investment and speculation are now indistinguishable.

All market activity lies on a time continuum. Moving from left to right, we observe buy–sell decisions in the stock market that occur in microseconds, minutes, hours, days, weeks, months, years, and decades. Although it is unclear exactly where the demarcation line is located, it is generally agreed that activity occurring on the left side of the time continuum is more likely to be speculation, whereas activity residing on the right side is thought to be investing. In Bogle’s opinion, investment means long-term ownership whereas speculation is more short-term trading. Carret concurred, writing: “The time requisite for the accomplishment of the adjustment of prices to values is a factor of great weight to the speculator. Here he parts company with the investor, to whom it is of little concern.”

Thinking long term or short term might be a sensible starting point that helps us distinguish between investing and speculation. But a “stopwatch” definition leaves us woefully short of what is ultimately needed to better understand the differences between these two approaches. A time element is simply not sufficient. The distinction between investment and speculation is more complex than this.

Let me be clear: This not a sneaky attempt to demonize speculation and declare that only investing is sacrosanct. Academic research clearly demonstrates that the market benefits from, and is optimized by, the participation of both investors and speculators. Although some investment purists might vote for opening the stock market just one day each year and on that day all buyers and sellers would transact business, the lack of daily liquidity would likely do more harm than good for the capital markets. Furthermore, despite its negative connotation, it can be argued that some types of speculation are, in fact, socially redeeming. Lynn Stout, Distinguished Professor of Corporate and Business Law at Cornell Law School, in “Uncertainty, Dangerous Optimism, and Speculation: An Inquiry into Some Limits of Democratic Governance” argued that a speculator that provides insurance and liquidity for the risk-averse farmer who wishes to enter into a forward contract to sell his wheat at today’s price deliverable next month “fits the standard economic model of mutually beneficial exchange that improves the welfare of both trading parties.”

In addition to risk hedging and liquidity dealing, Milton Friedman told us that speculators who practice what is today called “information theory arbitrage” should be thought of as talented researchers who work aggressively to close the price–value gap. Carret shared the same opinion. He wrote: “The speculator is looking for hidden weak spots in the market,” and as such, acts as “the advance agent of the investor, seeking always to bring market prices into line with investment values.”

Even Graham in The Intelligent Investor came to accept the necessity of speculation. “Outright speculation is neither immoral, nor (for most people) fattening to the pocketbook. More than that, some speculation is necessary and unavoidable.” But Graham was quick to distinguish between “good” and “bad” speculation. “There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent,” wrote Graham.

But how can we distinguish between what is “good speculation” and “bad speculation,” or “good investment” and “bad investment” for that matter, when we don’t even have a firm grasp of the basic definitions? Lacking clearly understood boundaries, individuals are wandering aimlessly back and forth between the worlds of investing and speculation. And herein lies the danger. The stock market is now dominated by a newly evolved species, the investulator — defined as an investor who unwittingly acquires speculative habits without realizing it. Although more study is needed, it is highly possible being an investulator is the reason why so many individuals perform badly in the stock market.

There is a very important passage in Graham’s The Intelligent Investor. Graham wrote: “The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern. We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to emphasize it in all its dealings with the public. Otherwise the stock exchanges may some day be blamed for heavy speculative losses, which those who suffered them had not been properly warned against.” True today as it was 60 years ago.

So, let’s begin. What is the definition of investing? What is the definition of speculation?

Editor’s note: please feel free to respond below, or continue on to read responses from Howard Marks, CFA, Martin Fridson, CFA, Malcolm Trevillian, CFA, and W. Bradford McMillan, CFA .

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Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

43 comments on “What Is the Difference between Investing and Speculation?

  1. To me, speculating has to do with the notion of buying something with the idea that you will trade it to someone else as soon as you can realize a favorable price , while investing would imply a willingness to own that something for an extended period of time without worrying much about the short run or temporary impairments of capital. It may also have something to do with how much work you have put into trying to understand the underlying/intrisic value of that something.

  2. Kenny Yang said:

    Warren Buffett, who was Graham’s best student, has a definition which I agree with. An investor is one who seeks return from the underlying asset itself, whether be earnings/dividends from the underlying company for a stock or rent from a property if it is real estate. A speculator on the other hand seek returns from pure price appreciation. Also in my opinion, an investor sees the stock as a business, while a speculator sees the stock as a ticker symbol. In the mind of an investor, he/she is owner of a sound and profitable business while in the mind of a speculator, he/she is playing a zero sum game trying to beat the other people in the market.

    • Bob W said:

      Berkshire Hathaway doesn’t pay a dividend and isn’t real estate. Most people buy BRK shares in the hope that their value will appreciate. Does that mean buying shares in BRK is speculation?

    • Drew Robertson said:

      This works for me. A speculator has the same motivations as a house flipper while an investor is like the house buyer who intends to pay off his mortgage. As for me I spend more time speculating but make more money investing.

  3. Cameron Lintott said:

    If I can be forgiven I like to use a poker metaphor to describe the difference between investing and speculation. For me investing is where you are dealt a good hand and slowly increase your stake as the hand improves, seeing how the other players react and how the cards are played, speculation is more a bluff, you are dealt a hand and you can take a guess at how good it may be but you cannot see any future cards, however, you bet large on the chance of a big win regardless of the uncertainty. A good poker player (investor) much like in the words of de la Vega, plays a mixture of the two, a mixture of risky bluffs and calculated less risky play.

  4. john said:

    This is perhaps the most important topic of out time. Many times, the value of the business diverges sharply from that of the market…witness the 2000 period dot com runup as an example. If you were the holder of a pension asset during the period, your interests will ill- served by money managers chasing an index so as not to underperform and lose clients. of course, the pension holder suffered greatly form those who indexed their funds in the subsequent period.
    Another way of saying this is to look at vanguard- a firm which indexes for a living. look at their returns from 2000 and ask whether one wouldn’t have been better off in simple corporate bonds.

  5. Satya said:

    Investing vs. Speculating = Analysis vs. Guessing

    The other comments had some great thoughts as well. Using time span to differentiate between investing and speculating does not capture the essence. Similarly, exiting a “trade position” after having achieved a target return in a short period of time, may not necessarily classify it as a speculative trade.

    • The difference is semantic. We’re all maximizing inter-temporal utility – the enormous degree of subjectivity introduced by attempting to objectively distinguish between investing and speculation makes the practice futile. They’re not diametrically opposed, but sit right next to each other on a continuum of acts wherein people sacrifice a certain amount of utility in one time period hoping to realize a greater amount of utility than would have otherwise been possible in another.

      What connects a lifetime pension contributor who passively selects mutual/target date funds for his retirement and a guy looking to make his dreams come true by buying calls on tech stocks into Q1 earnings is stupidity. Or, to keep it general, an inter-temporal utility function subject to conditions that, when maximized, leads to behavior we might find ‘irrational.’

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  7. JoeG said:

    I see investing and speculating as “symmetrical” opposites of each other that share the same goal, namely, making a profit.

    Investing contains a component of speculating, and speculating contains a component of investing. The main emphasis in investing is on the value of the assets underlying the investment with the expectation that it will create a desired return (i.e., profit), and less emphasis on the price fluctuations (which is the speculative component).

    On the other hand, the main emphasis in speculating is on the price fluctuations with the expectation that it will create a desired return (i.e., profit), and less emphasis on the value of the assets.

  8. santiago mier said:

    Investing is the process of sacrificing the present value of a good (be it cash, time or some other type of asset) for it to multiply by the underlying growth of an ongoing or future opportunity (be it a project, a stock or asset) with solid economic fundamentals and approximately measurable risk obtained through thorough analysis and rational behavior. Therefore the risk/return objectives can objectively stated bounded by a time frame and can also be used for hedging. An investor can only go long to attain his specific risk/return objectives, if he goes short it is merely to hedge against unpredictable risk.

    Speculation is also the sacrifice of the present value of an asset to obtain a benefit from the growth or losses (and loss is key) of an ongoing or future opportunity. Speculation can or cannot be based on solid fundamentals, thorough analysis and rational behavior. Speculation can have out sized returns or losses due to the uncertain nature of the underlying opportunity, it seeks to exploit volatility. Since short term volatility tends to be smoothed over time, speculation has a smaller time window. Speculation and hedging are also mutually exclusive, as Merton Miller stated “if you do not hedge you are a de facto speculator” which also reinstates that speculation mostly benefits from uncertainty.

  9. Matteo Lombardo said:

    “There are always three games going on in the market at any time: a game of chance, a game of skill and a game of strategy. Games of chance are gambling; games of skill are speculating; and games of strategy are investing. The best way to understand this is to look at the definitions. Investors, like Warren Buffett, want to find the underlying value of a company. The time horizon is the same time horizon it takes to work out the company’s strategic plan, usually years and decades. The speculator doesn’t care about the underlying value of the company. He cares about the underlying demand of buyers and sellers in the stock. He is looking at the beauty-contest aspect: will people like the stock and bid it up or not. And the gambler is just a more speculative speculator, making a bet because he’s got a hunch that he knows what’s going on.” (Alfred R. Berkeley)

  10. RD said:

    For me, the difference between speculating and investing is affected by liquidty risk.

    Focussing on the time frame or the intention takes attention away from a crucial and often forgotten part of the process: The need for someone to take you out of your transaction.

    I think that if your plan involves eventually selling your asset to someone else, whether that is in 8 seconds or 30 years, then you are speculating, not investing.

    If you need someone to “take you out” of a position in order to make a return, then you are exposed to liquidity risk i.e. the risk that the market may not be able to buy at the time you wish to sell, and vice versa.

    This definition puts most stock market “investing” in the speculation category, since most people plan to exit their position by finding another monkey willing to buy it.

  11. Ian MacLeod said:

    The persistent speculator is comprised of all those who have no usable information about what their appointed ‘investment’ advisor is being told to buy by another advisor, neither of whom knows, within any statistical fidelity, what they are doing. They operate on luck, confidence, and Hugo Boss. Those things disappear in that order, but usually they have feathered their nest, not by making a profit for themselves (and their clients) but by the sure and simple way of taking a commission. The only way to invest is to invest in yourself and your immediate family. That way has been lost to most, due to the discount people place on future consequences. It doesn’t matter how much money you have when it either disappears due to a ‘market correction’ that no one saw coming, or when it can no longer be exchanged for what you need, when you need it. One could go on and on, but I find it sufficient to say that no one knows what is going to happen in the future, and the farther one sttempts to speculate, the more chaotic are the predictions that any modelling used up to now have supplied. One thing appears to have held constant, and that is that human physiology hasn’t changed appreciably over humdreds of thousands of years, however, the last few generations have managed to confuse the investing of money with the investing of right action.

    Ian MacLeod

  12. Will said:

    I’m one of those people who looks at the question and has difficulty seeing any meaningful distinction. The distinction becomes especially blurry when you consider a casino owner.

    It seems clear that owning a business like a casino is a long-term investment. But a casino owner’s profits in any given night come from the thousands of short-term speculations he engages in. The fact that the odds are in his favor make it seem less speculative. But then how is he any different from the speculative computer with the odds in its own favor that makes thousands of trades per day?

  13. Con Keating said:

    Liquidity is the key, in my opinion, to distingusihing between investment and speculation – the source of the liquidity.

    If we are relying upon the contract and for example collecting the coupons and principal of a bond, the source of liquidity is the obligor under the contract. If we are relying upon sale of the asset in a market, this is speculation. We are, after all, uncertain that the market may exist or that the price will prove satisfactory.

    This also delivers a time dimension and shades of grey between these – in general the longer we hold an asset the more income is non-market.

    I have written a number of articles in the past year on this – happy to send them to anyone who would like to read them – drop me an email at: con.keating@brightrockgroup.co.uk

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  16. Investing is the relentless process of translating and refining tacit knowledge into a distinctive and unique investment framework or mental model that is scalable beyond one single person and adaptable in different relevant contextual situations, particularly in dealing with what we do not know. Investors write with a framework as the north star to guide and navigate the marketplace jungle where dangerous animals, poisonous creatures and alluring sirens lurk at the corner. Speculators never bother to write. Investors care deeply about ideas and research. Speculators care solely about “making money”. Writing, research, ideas, knowledge – these are frivolous/useless pursuits with no immediate or short-term profits to Speculators. Investors have an instinctive longing to weave outside our own skin some reflection of our mind. Investors uphold the notion of responsibility, which emphasizes the active nature of the agent/knower, as well as the element of choice involved in the activity of the agent/knower, who can be assessed to be responsible or irresponsible as having fulfilled his obligations to fellow enquirers as part of membership in a community. Getting closer to the truth as a result of one’s virtues is more valuable for Investors than getting it on the cheap for Speculators.

    KB (Singapore)
    http://bambooinnovator.com/2013/03/01/robert-hagstrom-what-is-the-difference-between-investing-and-speculation/

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  18. satish gupta said:

    This article worthy for the students who are studying finance and for the people who are somehow connected to stock market.It gives a basic understanding of investing and speculation in a well defined manner.must read article.

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  20. robert said:

    I think for the most part the difference is that investing consists of investing sum X for a reasonably well-known, predictable return Y: whether Y is coupon payments from a bond, dividends from a stock, royalities from an oil well, rent from real estate. Speculation is purely price-driven, without expectation that cash or value will otherwise transfer to you from the investment.

    There is always some overlap, in that my future returns are not guaranteed, might go up or down, and I certainly enjoy capital appreciation as much as anyone; but in my mind, if something doesn’t pay me cash regularly in exchange for my investment, it is speculation, pure and simple. So in that context, the vast majority of participants in the stock market, including most mutual fund and 401k participants, are purely speculators.

    I know that sounds extreme, but IMO most such participants blindly send money to their 401k every month and hope it sticks, with no basis for a expected return other than “past performance” over a time frame that is itself arbitrarily chosen. And that also includes stockholders of BRK, everyone’s favorite sacred cow; Buffet himself is an investor, focused closely on expected cash flows, but the individuals who buy BRK stock are simply speculating that Buffet will do well.

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  22. Robert C Gray said:

    A situation seemingly confusing or complex likely means you have it wrong. Truth is usually pretty simple. Graham has it somewhat right if you interpret “return” correctly. But FINRA, and most of the financial services industries has is wrong. It is one of several semantic distinctions we have lost – including journalism vs propaganda in recent decades.

    As an equity buyer you do not own the retained earnings. You have the right to sell your security and you have any dividends or yield declared for shareholders. The dividends are your return on your capital investment. No dividends, no investment. Without dividends, it is a 100% speculation, with price being simply a function of what some other buyer (properly labeled speculator) is willing to pay.

    I have set this out in dozens of conversations over the past five years and written it in similar quantities of web postings. Pretty much 1% gets its it and the closer the other 99% are to the financial industry, the cool-aid takes over, and they are sure I am wrong and begin a long conversation argumentative about risk.

    I get that the industry does not want its retail customers to get this distinction. And many of those same customers do not want to think they are speculators, speculating on speculations. Being an investor, investing, on investments is a better spin for sales, for sleep-at-night, and for convincing one’s partner all is well. In 2008 many, unfortunately were shocked at their security value declines. Few understand they were all in speculations.

    Robert, above, got it right about Buffett – he is a hypocrite investor, failing to provide anything more than a speculation to his capital suppliers. Shame. I have personally requested, the past two years the “reporters” invited to his annual meeting to confront him on this. None have dared do it. The media is part of the cool-aid!

    Buffett does have the “sell when others are creating a bubble” an “buy when others are panicking” part right. What is not to like about buying more yield for less?

  23. Ravi Kumar said:

    Hello,

    In the real world who ever invests would invest by considering the possibilities of all risk factors and would form a strategy at least to safe guard the principle amount and to earn a better return (i.e Investor), but still due to the uncertainty and sudden shocks during long-run that an economy might experience or due to the better opportunity costs that prevail by then (because of increased globalization), a rational investor would tend to get out of his/her initial investment and go for the better (which act may be referred to as a Speculation). Hence,

    Investing: An investing is one which also contains speculation which would be exhibited by the investors, wherein they only dispose their investments when they fall in the phase of “having better opportunity costs relative to their initial investments, changes in the capital market expectations and their own utilities & when there has been a slow down in economy pertains to their investments”. In the phases mentioned above a rational investor would make sale of his/her initial investments and go for the better one’s.

    Speculation: A part of investing, where the investors turns out to be speculators and try to dispose their investments very frequently irrespective of the situation demanded (means regardless of the occurrence of the typical phases mentioned in the definition of Investing).

    Investments in an economy whose markets are informational and operationally efficient and with no country risk and no exchange risk would let people to be investors with not churning their investments, if not they are speculators.

  24. Lance Durham said:

    Graham & Dodd got it right. Tables won’t work in these boxes, so this 2×2 matrix may not display well in all browsers:

    2X2 Matrix of Analysis Results:
    safety of || satisfactory return ||
    principal || true | false ||
    true || investment | speculation ||
    false || speculation | speculation ||
    *It is also speculation if there is no analysis.

  25. Mr. Smith said:

    I like the distinction between speculation and gambling. Gambling is when a person places a bet without knowing the odds of winning. Speculation is when a bet is placed only when the odds of winning are known.

      • andrew jackson said:

        Playing roulette is gambling; there is a percentage chance of winning and losing.
        Owning the casino is investment; over the long term, the house always wins and pays a dividend to its owners.

  26. Mauricio Bedoya said:

    Investing: short / long term asset allocation in which you feel comfortable and ALLOW YOU TO SLEEP WELL at night.
    Speculating: short / long term asset allocation in which you feel comfortable but DOES NOT ALLOW TO SLEEP WELL at night.

    I dont try to make a theoretical distinction, because PERSONAL paradigms come to play, and debate will continuous, with no future end.
    Is like the psychological question: What is right or wrong ?, depends on personal paradigms and believes. What is ok for you, I can perfectly find it wrong.
    If you know the odd of wining, you aren’t speculating or investing, for sure, you will be rich in the future. But this does not happen in real life. So, lets come back to reality, and try to survive in the cannibal jungle of finance.

  27. absinop said:

    Regardless of how we are characterized, we commit our money into an asset(e.g., stock, etf, MF) with the hope that at some point in the future, the value of that purchased asset will have increased, and accordingly we can profit if we were to sell the stock. An investor has more knowledge of the enterprise than the speculator. The investor has perhaps even made himself familiar with the products, finances, and stock behavior. The speculator, on the other hand, might only just know the stock symbol. The investor convinces himself by the the preponderance of positive information he as learned, or concluded, about the enterprise, that if that continues it can only benefit the value of his holdings in the enterprise. The speculator could care less about the enterprise. He (or she) expects that some event, preferably in the near future, e.g. earnings spike, will drive the stock price forward to a satisfactory profit level, and he will then sell and move on to his next opportunity.

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  29. Dan Spencer said:

    A speculator makes decisions on a story or theory; hoping for price appreciation (depreciation). He is so convicted in his story that he often overlooks the risks.
    An investor is first and foremost concerned with risk or margin of safety. He makes decisions after determining the intrinsic value of an asset, and never relies on a story or hope.

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  33. Stephen Mras said:

    I’ve always paid heed to the fact that a share of stock represents the residual interest in the earnings of the respective company. If you were to buy a private company that has no daily marking of value, what would you focus on to determine its value? Cash flow and free cash flow. So it follows that I am amazed that people “invest” in companies with promising products yet have never generated a profit in their entire existence that spans 10 years. Such a position could only be described as speculative.

    Robert, I met you at the Legg Mason Conference in Las Vegas back in 2001 or 2002. At the time I questioned you about your position in XM Satellite as I felt it was speculative, or at least over priced. At the time it was trading in the $30+ range. After a couple rounds of questions from myself, you finally broke down and admitted that it was speculative, but there was room for a small speculative position in the portfolio. Curious what you did with that position and how you made out?

  34. bold'un said:

    I think we need three concepts: speculation, carry and portfolio.
    Speculation is the belief that price will change in the future, particularly of a commodity. Some speculations have positive carry, say if you can buy a building with a mortgage and let it out for more than the interest cost. Others have negative carry, like when you buy a gold future which costs more than the spot price or when you play at a roulette table where a zero makes the odds unfavourable. A dividend on a share is another example of positive carry. A portfolio is a set of speculations with positive carry where you hope that diversification will even out the winning and losing speculations to leave you holding the carry.
    Portfolio is only one type of investment, but the latter term has a wide application, meaning anything you build in the present for a future payoff.

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