Speculative Capital

What Is Speculative Capital?

Speculative capital incorporates those funds reserved by an investor for the sole purpose of speculation, and that means that those funds are reserved for high-risk/high-reward investments. This capital is often associated with extreme volatility and a high probability of loss. Most speculators have short-term investment horizons and often utilize high degrees of leverage in their efforts to obtain profits.

Speculative capital, otherwise called risk capital, can be contrasted with patient capital, which is intended to be long-term and oriented to well-informed, quality investments.

How Speculative Capital Works

Speculative capital is the funds that are viewed as expendable in exchange for the opportunity to generate outsized gains. Investors must lose their speculative capital, which is all why it ought to just account for 10% or to a lesser degree a typical investor's portfolio equity. Experienced investors with high-risk tolerance might allocate a quarter or a greater amount of their portfolio to higher-risk investments. That said, any investments made with speculative capital ought to be offset with additional stable diversified investments so you don't face the possibility of losing your entire portfolio.

The more risk-averse the investor, the lower the proportion of speculative capital allocated in the total portfolio ought to be. While more youthful investors, as a result of their longer investment horizons, can have a more significant proportion of risk capital in their portfolios, retirees are not generally comfortable with a high proportion of speculation — nor would it be a good idea for them they be, as their time to make back losses is limited. Generally talking, speculative investing ought to be segmented to the early long periods of investing and cordoned off as retirement age approaches.

Special Considerations

Given the better than expected probability of loss in speculative trading, it is critically important to exercise great risk management and not become emotionally attached to a certain trade. All it isn't uncommon to see beginner investors hold onto a position until it loses practically its value. Given their limited experience, new kid on the block traders ought to see all their tradable capital as speculative capital. In other words, they ought to just invest whatever amount of money they can stand to lose without their lifestyle being materially affected.

Since no two investors are identical with regards to risk tolerance and financial objectives, designating certain portions of capital "speculative" will differ widely across investor archetypes. Maybe a better method of identifying speculative capital is finding the amount an investor is willing (or able) to lose without risking their investment plans or financial objectives. In reality, whenever there is a chance for loss, an investor is speculating. Even virtually without default government T-bills might be speculative in nature; as it were, investors are speculating on inflation.

Mental Accounting and Speculative Capital

Mental accounting is a common strategy for financial planners to accommodate the speculative itch for investor "play money." Mental accounting alludes to the tendency individuals need to separate their money into different accounts in light of miscellaneous subjective criteria, including the source of the money and the intended use for each account.

The theory of mental accounting suggests that people are probably going to assign different functions to every asset group in this case, the result of which can be an irrational and detrimental set of ways of behaving. Since certain investors like to pursue trends, a financial planner can reserve a certain portion of assets or inflows, like money from a bonus, for speculative transactions. This approach satisfies investors' cravings for chasing returns, or stocks they catch wind of at neighborhood BBQs, but doesn't risk an entire portfolio.

Highlights

• This capital is therefore often associated with extreme volatility and a higher probability of loss.
• Since no two investors are identical with regards to risk tolerance and financial objectives, designating certain portions of capital "speculative" will differ widely across investor archetypes.
• Speculative capital is characterized by funds set to the side for high-risk, but potentially high-reward speculative investments.