I recently saw an article by a ‘wealth guru’ who stated that you “should do both – trading and investing” to create wealth faster. While I appreciate the logic behind this statement, I must admit that the “should’ part put me off. However, I was also intrigued by the idea of sharing with you my stance on trading and investing considering that I have extensive experience in both.
Investing and trading are two very different methods of creating wealth. While there are people who make money by employing either or both methods, it’s very important to be clear which one suits you – your risk tolerance, your time horizon and your financial objectives.
The goal of investing is to gradually and strategically build wealth over an extended period of time through buying and holding income producing and appreciating assets (e.g. rental real estate, individual stocks, baskets of stocks, mutual funds, bonds and other investment instruments.) Investors often enhance their profits through compounding – reinvesting their profits or dividends into additional shares of stock.
Because investors usually hold assets for a longer period of time, they can take advantage of accruing interest, dividends and assets’ value appreciation. Thus, investors are usually able and willing to ride out market fluctuations knowing that markets can rebound and their losses can be recovered. Investors usually use fundamental analysis tools to analyze the assets (e.g. specific company stock, etc.)
Traders, on the other hand, buy and sell assets frequently with an intention to generate quicker and higher returns than ‘buy-and-hold’ investors. For example, while most investors are content with an 8%-10% annual return on their capital, traders might seek an 8%-10% monthly return.
In a ‘bull’ (upward) markets, traders generate profits by buying low and selling at a higher price within a short period of time. In a ‘bear’ (falling) markets, many traders use ‘selling short’ strategy by selling at a higher price and buying at a lower price (to cover their ‘short positions’). Traders often use technical analysis tools to find high-probability trading opportunities.
There are several categories of financial markets’ traders:
- Swing Trader – they hold their positions for several days
- Day Trader – they hold positions throughout the day
- Scalp Trader – they hold positions for seconds or minutes
In real estate markets, ‘flippers’ or ‘wholesalers’ buy properties with an intention to re-sell them (‘as is’ or after renovating them) within weeks or months. Real Estate investors, on the other hand, buy properties with an intention to receive income, deduct expenses and depreciation, and hold them for a long period of time to enjoy their assets’ appreciation.
If you are an investor, typically it means you are a person who is holding on to assets for the purpose of earning passive income and getting a profit when you sell your assets.
If you are a trader, you attempt to take advantage of short term market swings. You buy an asset when the price is low (in your opinion) then sell it shortly after with an intention to receive a profit from the short-term increase in value of this asset.
Both investing and trading involve risk. However, I consider investing to be a process with a relatively predictable outcome. Excluding market crash or companies’ bankruptcies, you can expect to receive income from rental properties in good economic locations and interest over the life of the bond (and your principal capital at maturity.)
Trading, on the other hand, has outcomes that are more difficult to predict. When one purchases a stock or an equity mutual fund, there is really no way of knowing with 100% certainty in advance whether it will go up, down or sideways. That’s why you must have specific risk management rules when trading.
Is it possible to make a lot of money by trading (aka speculating)?
Admittedly, there are some very successful speculators out there. However, to be successful, most of them do it professionally, have a team of researchers and are very well connected so they get insights on the assets that they speculate on. If you want to be a successful trader (speculator), you may consider doing it full time and follow the successful professional speculators by subscribing to their newsletters, events, etc.
In my opinion, trading is speculation that has nothing to do with investing. As a trader, you are trying to find assets (e.g. stocks, properties) that have shorter-term opportunities. You can make money, and you can lose money very quickly by taking short-term trading positions. It’s a risky proposition in my opinion, especially if you’re not savvy about analyzing financial information. The markets can move swiftly both up and down, so beware and make sure you can stand to lose.
Long-term investing, on the other hand, is about achieving your financial objectives in a methodical strategic way – allowing your financial goals and current financial situation to determine an appropriate investing strategy and build an investment portfolio to satisfy your financial objectives over a period of time.
Think “investing” as a form of planning to send your money into a battle, and “trading” as sending your money into a battle for a quick grab of profitable asset because you believe it’s possible. Ideally you want to have a plan first before any implementations, but in reality, many people are ready to trade because they feel they need to catch up with their wealth creation efforts.
Yes, it is natural to want to get rich fast, and seeing your family, friends, or a wealth coach doing well financially often motivates you even more to catch up. However, these people’ situations may very well differ from yours. They may have a big emergency fund set up or several passive source of income so they’re comfortable with their trading efforts even if they lose from time to time.
And it’s not uncommon when someone feels worried or desperate to make money from trading only to get a double-whammy at the worst time! So, ask yourself, “If I’m a general and have to send my solders to a battle, would I do it without a plan?”
If the answer is No, you know you need to educate yourself more about possible options and investment strategies that are right for YOUR financial situation. And once you get a solid foundation in a form of your financial education, you may want to talk to a financial professionals like a financial adviser or a financial planner to help you implement your financial objectives so that you don’t lose your ‘army in a battle.’
When you have a long-term outlook on your wealth building efforts, you realize that the markets – whether it’s real estate, bond or equity markets – will inevitably rally as well as go through pullbacks. That’s why I like to invest in diversified assets that provide income and compounding opportunity, value appreciation, and allowed deductions.
Therefore, in my opinion, there are NO SHOULDs when it comes to choosing how you grow your wealth. However, it’s important to know your options.
To Your Health, Wealth and Freedom!
P.S. Share you experience with Investing and Trading. What works for you?