Invest vs. Trading: what is best for you?

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People involved in the stock market have many ways to make money, but these strategies can be boiled down to two major ones: investing and trading. You could say that the difference between each strategy comes down to two things: the time horizon (how long you are willing to hold a position) and the mindset (whether you think of yourself as an owner or as a pinball machine for. short-term profit).

Unlike what you see in Hollywood movies and TV, research suggests that the vast majority of market participants – practically all – would do better if they adopted an investor mindset rather than a trader. And this is due to the many subtle costs and inefficiencies of trading.

Here’s the difference between investing and trading, and which one is likely to work best for you.

Investing vs trading: what’s the difference?

“With trading, you make money by doing something; by investing, you earn money while waiting. It’s a phrase that could sum up a key difference between investing and trading. Let’s break down the other key differences to see how they stack up:

Invest

If you invest, you take a long-term view of your investments and you will do the following:

  • You think like an owner, that is, on the performance of the business rather than on what the action will do.
  • Your long-term performance is fundamentally based on the performance of the business, as opposed to your ability to buy and sell better than other traders.
  • You think of the business as a business – its products, its competition, and the evolving rivalry of the industry.
  • You don’t worry about daily fluctuations in the stock price, especially if the long-term trajectory of the company is on the right track.
  • Because you think further, you get rid of negative short-term market reactions, such as when the company announces quarterly results.
  • You are able to patiently wait for your investments as they grow.
  • You see a drop in the stock or a fund as a potential chance to own more good companies at a reduced price.
  • If you invest in funds, you will tend to take a more passive approach, regularly adding money to your portfolio rather than trying to synchronize the market.
  • You sell investments based on process and discipline – when the investment case went – rather than because they performed well this week or month.

Being an investor is about your mindset and process – long term and business driven – rather than how much money you have or what a stock is doing today. You find a good investment, and then you let the success of the business drive your returns over time.

Trade

If you negotiate, you focus a lot more on the short term and you care less about the business as a business. You will likely do some or all of the following things, such as:

  • You’re less interested in knowing if the underlying business will prosper, and more in knowing if the stock can make you money.
  • You want to know what others think about a trade, because you are not only playing the stock or the fund, but also the other players at the table.
  • You can watch short-term price movements, even look at minute charts to predict the best time to buy or sell, and you “sync the market”.
  • Stock prices determine your behavior rather than the fundamentals of a company.
  • You are likely to ride dynamic stocks and look for stocks that are on the rise today rather than those that are priced with a margin of safety.
  • Your holding period tends to be short (maybe just a day, if you’re a day trader, or maybe a few weeks or a few months) depending on your specific strategy.
  • You can sell investments depending on process and discipline, but these trading rules have a lot more to do with what you gain or lose than they do with the business itself.
  • You may need to pay more attention to the market than you as an investor because you have to make buying and selling decisions frequently.

Traders tend to have a short term focus. Being a trader is less about analyzing a business and more about examining its stocks as a way to make money – and ideally the faster the better. Success here relies on guessing the next trader, not necessarily finding a good business.

Investing works better than trading for the most part

If the distinction between investing and trading looks a lot like the distinction between active investing and passive investing, it should! These pairs of investment approaches have many similarities.

Passive investing is a buy and hold strategy that leverages the fundamental performance of the underlying companies to increase returns. So when you take a stake, you expect to hold it for a period of time, not just sell it when the price goes up or before the next person unloads their stake.

Passive investing through funds (either ETFs or mutual funds) allows you to profit from the performance of the target index. For example, the Standard & Poor’s 500 has averaged 10% per year over time. It would be your return if you had bought an S&P 500 index fund and not sold.

Active investing is a strategy that tries to beat the market by trading in and out of the market at advantageous times. Traders try to pick the best opportunities and avoid falling stocks.

While active investing seems to be the constant winner, research shows that passive investing tends to win most of the time. A 2018 study from the S&P 500 Dow Jones Indices shows that 63% of fund managers investing in large companies have not beaten their benchmark in the past 12 months. And over time, only a handful have been able to do so, with 92% of professionals unable to beat the market over a 15-year period.

They are professionals who have the experience, knowledge and computing power to help them excel in a market dominated by turbocharged trading algorithms with well-tested methodologies. This leaves very few crumbs for individual traders without all of these benefits.

Investors are therefore more likely to prefer a passive approach to the markets, whether investing in individual companies or funds. Traders are more likely to prefer an active approach.

3 hidden costs of trading to watch out for

Trading has a number of hidden costs, things that ultimately make it less profitable for most traders than sticking with an investment approach. Here are three of the most common:

1. Trading is a zero sum game

Trading works on what is called a zero sum game. That is, if someone wins, it comes to the loss of someone else. For example, options trading is essentially a series of side bets between traders on the performance of a stock. If a contract is in the currency of $ 1,000, the winning trader gets exactly that money, effectively taking it from the losing trader.

So, trading is just a matter of shuffling money from player to player, with more savvy players accumulating more money over time from less skilled players. In contrast, investors play a positive sum game, where more than one person can win. Investors make money when the business is successful over time.

2. It’s easy to miss the big days as a trader

Traders may think they are tricky at dodging and dodging, but they often miss the biggest days of the market because they are out of the market or have only partially invested.

A recent report from Bank of America reveals just how damaging being out of the market can be. The data shows that the total return of the S&P 500 from 1930 to 2020 was 17,715%. But what is the total return if you only missed the 10 best market days each decade? The result: a total of just 28% over the entire period, after missing less than 100 days in total.

Market experts have a saying: “Time spent in the market is more important than timing in the market”. That is, it is more important to stay invested than to try to dodge losses and make gains. And this is where the long term mindset of an investor helps you focus on the future. You get through the bad days because the market as a whole is on a long term upward trajectory.

3. Traders accumulate taxes

You create a tax liability every time you make a profit on a sale of assets. So traders entering and exiting the market are making profits (or losses) all the time. This reduces their ability to compound earnings because they have to reduce the IRS for a slice of every win they make.

In contrast, investors tend to let their investments run. And because the government doesn’t require you to pay tax until you sell an investment, investors can capitalize at a higher rate, all other things being equal. In other words, they effectively force the government to give them an interest-free loan by deferring their taxes, and they continue to capitalize on the full amount before tax.

For example, imagine that you started with $ 10,000 and earned 20% per year for five years, but sold each year and paid 20% tax each year. At the end of the five-year period, you would have assets of $ 21,000, which is roughly 16% of annualized earnings. Not bad!

But you will have even more if you had not sold. Without selling, you would have turned that $ 10,000 into more than $ 24,883 and you would have kept the full 20% annualized earnings. What if you decided to sell then? You would still have $ 21,906 after tax, or nearly 17% per year over the period.

It is a hidden advantage that investors have over traders.

At the end of the line

The evidence is generally clear that investing is a strategy that works best for most people. Can some people consistently beat the market? Absolutely, no doubt. But for most people, it’s better to be an investor than a trader – and that can also take less time and effort.

Legendary investor Warren Buffett recommends that investors regularly buy into an index fund such as an S&P 500 fund and then hold it for decades. This approach follows the spirit of being an investor – taking a long-term view and letting businesses generate money for you.

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