Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

In recent weeks, some well-known and experienced investors have warned of increasingly speculative behaviour in financial markets.

In particular, the prices of a handful of shares have risen rapidly on the back of comments posted on social media networks.

Investors whose memories stretch back to the late 1990s will hear echoes of what became known as the dot.com bubble. This was a volatile time around 20 years ago when the prices of technology-related shares soared before, in many cases, falling back to earth when that bubble - inevitably - popped.

Periods of heightened speculation are dangerous for long-term investors because emotions run high and it can be hard to resist the temptation to get involved. The fear of missing out is a powerful force.

At times like this, the risks of investing increase. This is not just because prices that have risen fast can fall quickly too. It can also become hard to trade in and out of speculative stocks at times of market stress.

Investors might then risk material losses, as the Financial Conduct Authority, the investment regulator, has warned. So, it is important to weigh up this very real risk when deciding whether to invest.

Fidelity’s share dealing service will always try to fulfil orders at times of excess trading activity but there may be times when we are not able to do so.

Why speculation is not the same as investment

It is worth focusing on a key distinction - between a speculator and an investor.

An investor is a part-owner of a business. He or she provides the capital for that business to grow. The hoped-for reward for that support is a combination of dividend income and share price growth.

But building a business is a long-term project. It takes time, and investors need to be patient too.

They need to look through the short-term ups and downs of a share price to focus on the long-term accumulation of value in the businesses they have invested in.

A speculator, by contrast, is not interested in long-term growth. He or she is focused on short-term movements in price, hoping to quickly sell at a higher price than they paid.

The underlying business is irrelevant to a speculator. They do not see themselves as owners of a business. A share to a speculator is no more than a chip in a casino.

Investing is not gambling

In the long run, the price of a share will reflect the underlying value of the company that issued it. In the short run, however, the movements of a share price are random and unpredictable.

This is why speculating on short-term price movements is risky. It is why real investors learn not to attach too much meaning to day to day price changes - but to focus instead on the fundamental value of an investment.

This is easier said than done, however, when markets are volatile. Prudent investing might seem dull compared to the excitement of speculation.

This is especially true when prices are rising quickly and other investors seem to be making easy profits.

The self-feeding nature of speculative bubbles

When stock markets become more speculative, price movements can become self-fulfilling.

As prices rise, more investors become convinced that they will continue to rise. As they in turn buy into the positive story, prices rise further, attracting yet more investors….and so on.

This can happen until there are no new speculators left to participate. At that point the process can go into reverse and exciting gains can become terrifying falls.

The victims are the investors that were late to the party. Get rich quick dreams evaporate quickly. And when something looks too good to be true, it usually is.

Social media and speculative excess

Periods of speculation have been around for as long as there have been financial markets. From the South Sea Bubble to Tulip-mania and the 1929 Wall Street Crash, the history books are full of stories of excessive optimism turning to despair.

A key difference between all those manias and now is the role of the internet, and in particular of social media, to spread news, information (and sometimes mis-information) very quickly to many people.

Financial markets today are much more vulnerable to self-fulfilling bubbles.

Make your investments work for you

Investors should not be concerned by these periodic surges in speculative behaviour. If markets always reflected the real value of all investments, there would not be any opportunities to benefit from mispriced assets.

If history is a guide - and don’t forget that investment growth is never guaranteed - stock markets will remain a powerful way for us to participate in the innovation, hard work and desire to succeed that has always underpinned growth in the world’s economies.

But we should remain on our guard and stick to some key investment principles:

1. Invest with a long-term view. Be an investor not a speculator.

2. Be well-diversified. By putting your eggs in a variety of baskets, you can ensure that a problem in one part of the market does not put your long-term financial plans at risk.

3. Do not try to time the market. Picking the top or bottom of the market cycle is impossible. Far better to invest through the cycle to benefit from the long-term growth in the economy.

4. Save and invest regularly. By putting your money to work according to a fixed schedule you will avoid the emotional triggers that might otherwise undermine your investment success.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics covered:

Active investing; Diversification; Global; Investing principles; Regular savingsRisk and reward; Volatility

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