When counseling clients, financial advisors often distinguish between investing and speculation.
Investing, they say, generally means continually buying into widely distributed parts of the market, allowing compound interest to work over decades. “Real investing is boring. It’s like watching paint dry,” Ramit Sethi, author of How to Get Rich, told CNBC Make It in July 2023.
Speculation, on the other hand, is not exciting. Speculators purchase assets that offer very high returns and considerable risk of loss. And when it comes to building wealth, taking a little extra risk can pay off big, says Jim Cramer, host of CNBC’s “Mad Money” and author of “How to Make Money in Any Market.”
“I believe in speculation. I don’t think speculation is bad,” Kramer told CNBC Make It. “Guess wisely.”
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Kramer’s approach to portfolio construction combines diversification and investment in individual stocks, a system he also outlines in his book. He said about 50% of his investments are in passive mutual funds and exchange-traded funds that track U.S. stock indexes such as the S&P 500.
The remaining half is roughly spread over several stocks. Most of them should be high-quality growth stocks, he said. But one should be speculative, he says. Two if you’re early in your investing career. For young investors, speculation can be an essential way to increase their chances of building long-term wealth, he added.
“The number one thing young people need to do with their money is find ways to speculate,” Kramer said.
These stocks don’t need the same fundamental strength as other stocks in a portfolio, he notes. You may not get big profits or high valuations. It could also be a play about a long-term, world-changing theme that you believe in.
“Maybe you believe in quantum (computing). Maybe you believe in nuclear. Maybe you think there’s something really, really special about cryptography,” says Kramer.
Mr. Kramer’s strategy of betting a small portion of his portfolio on fences could work. Ask any early investor in Tesla or Nvidia if they wish they had stuck with a more diversified approach.
But speculating wisely means approaching investments with a full understanding of the risks and the potential impact of loss on your overall portfolio, says Kramer. You can easily lose every dollar you put into a speculative investment. In that case, youth may be an advantage. You have time to make up for the complete loss with a relatively small portion of your holdings.
“You’re young and you have a lifetime to earn that money back,” he says.
Some might say that approach is reckless, Kramer acknowledged. But giving yourself a chance for a life-changing return is worth the risk, he says.
“It’s not reckless; it’s smart,” Kramer said.
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