When looking to build wealth, many people think of trading vs. investing as basically the same thing. However, this isn’t necessarily the case. There are some subtle differences when you look at trading and investing.
Both approaches can be viable ways to build wealth and reach your financial goals. Understanding how to use both strategies in your portfolio can help you better manage your assets and work toward reaching your short-term and long-term goals.
Trading vs. investing: what’s the difference?
There may not seem to be a huge difference between trading vs. investing, but there are some distinctions that should be considered. In general, it’s worth noting that trading can be considered a type of investment strategy. However, when building your portfolio and growing your wealth, it can make sense to separate them and consider them as different approaches.
One important consideration is time horizon. For the most part, investing is more of a long-term strategy. The idea with investing is to build a portfolio over time and use compounding returns on consistent contributions to do most of the heavy lifting. With a long-term strategy, it’s possible to use investing as a source of passive income down the road.
On the other hand, trading is typically a more short-term strategy. Rather than investing money in a brokerage account and keeping it invested in the same thing for a long period of time, trading is about capturing gains immediately and using those to continue trading and building wealth quickly. For instance, swing traders and day traders employ an active trading strategy that may include frequent or daily stock trading with the goal of maximizing their returns.
The pros and cons of trading
Pros of trading
- Potential to make money in the short term: If you want to see quick gains, trading can be a fast way to potentially accumulate wealth. When you trade for profit, you can then use that money to continue trading and potentially building more wealth in a short period of time.
- Leverage: Depending on your situation, you might be able to borrow to make trades with a margin account, potentially yielding higher returns.
- Control: If you’re trading, you can control when to execute the trades. You have the opportunity to choose the stocks you want and set up triggers to sell when you reach a certain threshold.
Cons of trading
- Considered riskier: Often, trading is done with individual securities. Although the stock market, as a whole, trends higher over time, individual stocks might not. If you choose the wrong stocks, you could lose money, rather than seeing profits. Additionally, if you use leverage, it can increase your losses.
- Taxes: Short-term capital gains from a taxable account are taxed at your regular rate, so you lose the advantages that come with long-term capital gains. Although you could trade inside a tax-advantaged account and reduce some of the tax risks, it might be more complicated than simply trading from a taxable investment account.
- Frequent market fluctuations: With trading, you need to be on top of financial market fluctuations, which can be time-consuming. You often stray into market trends and timing, trying to figure out exactly when to enter or exit a position. Although there are automated systems that can help you avoid this, the reality is that it can be time-consuming to be involved with trading as you try to account for market fluctuations.
Who is trading right for?
For the most part, a trading account is most likely to benefit someone who has the time to pay attention to the markets and develop a strategy around taking small profits. In order to be successful at trading, you need to have a moderately high to high emotional risk tolerance, as frequent market fluctuations can feel like a roller coaster. And if you employ a day-trading strategy, your risk tolerance may need to be even higher.
Additionally, active trading is usually best for those who understand how much money they can afford to lose and don’t risk more than that. It’s also important to understand that, as a beginner, it can be difficult to see big gains initially with trading. Some traders use algorithmic trading or technical analysis and fundamental analysis tools designed to track price movements. So they might be looking for a tiny gain, but they have millions of dollars in the trade so that tiny gain means much more.
Although it’s possible for beginners to be successful and find a strategy that works for them, trading works best when you go in with realistic expectations.
The pros and cons of investing
Pros of investing
- Potential for long-term wealth: With investing, you have the potential to build wealth as you let your money grow over a long amount of time. If you make modest and consistent contributions to your investment account, time and compounding returns have the potential to grow your wealth beyond what you’d get with a savings account.
- More passive approach than trading: Investing often takes a more passive approach of putting money in, rather than trading out of investments or selling assets. Beyond rebalancing and managing some tax efficiency, investing is a relatively low-maintenance way to potentially grow your wealth over time.
- Potential tax advantages: Even when you use a taxable account to invest, you receive a lower capital gains tax rate when you hold an asset for more than a year. Additionally, investing is often associated with tax-advantaged retirement accounts, which allows you to potentially improve your overall tax efficiency.
Cons of investing
- Longer time frame of tied-up money: Depending on the type of account you use, the money you invest could be tied up for a longer time frame. For instance, if you’re investing in a tax-advantaged retirement account, you have to be comfortable with not accessing your money until later on. Early withdrawals can come with penalties and taxes.
- Fees: Depending on the brokerage and the account, you might end up seeing your real returns eroded by fees. However, many brokers are reducing their fees, and it’s possible to find investments with low costs.
- Potential for loss: Any time you invest, there’s the potential for loss. Even though the market as a whole has yet to lose in any 20-year period, there’s always a chance of loss. Additionally, you could start withdrawing money during a market downcycle, which is a risk as well.
Who is investing right for?
You’re most likely to benefit from investing if you want to grow wealth steadily over a longer period of time. Investing can also potentially work well for those who prefer a more hands-off approach to managing their portfolio. It’s often appropriate for those with low-to-moderate risk tolerance, and it’s also a key component of saving for retirement.
It can also work well for buy and hold investors who are in it for the long term with individual stocks or those who want to earn money from dividends.
Investing is generally appropriate for those who have some patience to ride out market downturns. With investing, it’s important to recognize that there will be downcycles and realize you need to continue putting money into your portfolio in order to reap the gains later.
4 tips for minimizing your risk
Whether you’re involved with trading or investing (or you do a little of both), it’s important to recognize that there is always the risk of loss. Risk related to the market as a whole, as well as individual assets, are real possibilities whether you invest or trade. If you want to reduce your risk, there are some things you can do.
1. Learn about investing before diving in
Do your research ahead of time. Learn how to invest money and how trading works before you jump in. One approach is to consider beginning by investing in mutual funds or ETFs and letting your money grow in the market while you research other assets and strategies.
Having a basic knowledge of how the market works and how trading and investing work can help you make more informed decisions about what’s right for you.
2. Choose the right wealth-building strategy for you
Consider your own individual needs and goals, and choose a strategy that works best for you. Think about your emotional and financial risk tolerance, and whether one strategy is likely to work better on your behalf.
It’s also possible to use both approaches in building your portfolio. For example, you might use a long-term investing strategy to grow your retirement nest egg, but trade in an attempt to meet shorter-term financial goals. Some people like trading because of the excitement it gives while investing the money they know they’ll need in the future using longer-term strategies.
Understanding your own needs can help you decide how much of your portfolio should be in long-term investments and how much is appropriate for you to trade.
3. Create a plan and stick to it
Whether you trade or invest, creating a plan is important. For trading, this might mean committing to sell when a security reaches a certain threshold or taking gains at a certain point. Sticking with your plan can lead to fewer losses, and it takes some of the emotion out of trading.
Creating a plan also works for long-term investing. Calculate what you need to set aside each month to try to reach your goals and then contribute that money regularly. Sticking to the plan through market downturns can also allow you to get more shares for less, and then reap the advantages of growth during a recovery.
Other strategies, like using a bucket strategy, can also be useful for long-term investing. Whatever you decide, create a plan that works for you and, even though you might tweak it, try to avoid wholesale changes in response to market events.
Choose the right platform
Review different platforms to find one that works well with your strategy and your long-term goals.
For traders, that might mean looking at a platform like Robinhood that doesn’t charge fees and allows you to make trades quickly and easily. For investors, there are robo-advisors like Betterment that can help you set aside money for the future while taking care of rebalancing and tax efficiency. This can be helpful if you’re a hands-off investor.
The best investment apps for you allow you to invest according to your own style and preferences while building wealth. Research a few of the best stock brokers to see what is likely to work well for your financial situation and preferences.
The bottom line on trading vs. investing
When deciding between trading vs. investing, consider your own goals and needs. When it comes to building long-term wealth in a way that is thought of as less risky, investing can be a good approach. On the other hand, if you hope to gain wealth quicker, trading might make sense for you.
In the end, though, there’s no need to choose between the two. It’s possible to use a combination of approaches, growing a long-term nest egg through investing, while using trading for a different part of your portfolio aimed at more immediate gains.
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