Trading vs. Investing: What’s the difference between trading and investing? In this video, Bob Powell, CFP, aka Mr. Retirement and Haley Ellis CFP® CPFA® discuss Trading vs. Investing and be sure to check out the article below for more information about Trading vs. Investing.
Trading vs. Investing: Trading and investing are two distinct approaches to participating in financial markets, each with its own objectives, strategies, and time horizons. Here are the key differences between trading and investing:
- Objective:
- Trading: The primary objective of trading is to profit from short-term price fluctuations in financial instruments, such as stocks, currencies, commodities, or derivatives. Traders often aim to capitalize on market inefficiencies, technical analysis patterns, or news events to generate quick profits.
- Investing: Investing focuses on acquiring assets with the expectation of generating long-term growth or income. Investors typically buy and hold assets for an extended period, aiming to benefit from the appreciation of the asset’s value over time, dividends, or interest payments.
- Time Horizon:
- Trading: Traders typically have short time horizons, ranging from minutes to days. They may execute multiple trades within a single day (day trading) or hold positions for a few days to weeks (swing trading).
- Investing: Investors have a longer time horizon, often measured in years or even decades. They are willing to tolerate short-term fluctuations in the market and hold onto their investments through market cycles to realize their long-term financial goals.
- Risk Tolerance:
- Trading: Trading involves higher levels of risk and volatility compared to investing. Traders often use leverage and take on significant risks to potentially amplify returns, but this also increases the potential for losses.
- Investing: Investing tends to be less risky than trading, especially for long-term investors who diversify their portfolios and adopt a buy-and-hold strategy. While investing still involves market risk, the focus is on managing risk through diversification and a long-term perspective.
- Decision-Making Process:
- Trading: Traders make decisions based on short-term market trends, technical analysis, and sometimes fundamental analysis. They rely heavily on charts, indicators, and trading strategies to time their entries and exits.
- Investing: Investors typically conduct thorough research and analysis of companies, industries, and economic trends to identify undervalued or high-growth potential assets. Fundamental analysis, which evaluates a company’s financial health and prospects, plays a significant role in investment decision-making.
- Frequency of Transactions:
- Trading: Traders execute a high volume of transactions, buying and selling assets frequently to capitalize on short-term price movements. They may enter and exit positions multiple times within a single trading session.
- Investing: Investors generally have a lower frequency of transactions, as they tend to buy assets with the intention of holding them for the long term. They may rebalance their portfolios periodically or make adjustments based on changes in their investment objectives or market conditions.
In summary, trading is focused on short-term profit-taking through frequent buying and selling of assets, while investing aims for long-term wealth accumulation through strategic asset allocation and patience. Both approaches have their merits and risks, and the choice between trading and investing depends on individual goals, risk tolerance, and time horizon.
Article: Trading versus Investing: What’s the Difference?
Understand the differences between the two strategies before you take action.
By Haley Ellis CFP® CPFA®
It seems like the stock market has taken over the news lately (ex. GameStop), as individuals have more access than ever through various brokerage platforms and the pandemic significantly increased the popularity of actively trading stocks. Both trading and investing have their benefits and risks, however, it is important to understand the differences between the two strategies (with the major disparity being time) before you take action. Trading involves short-term buying and sell of stocks and other financial assets with the goal of making a quick profit. This time period can be months, days, or even minutes. The goal is to earn higher returns than holding an asset for the long-term. It can be thrilling to trade, but should only be done with money you can stand to lose, just like gambling at a casino, as this can be very risky. If you choose to trade, start small and make sure you are funding your other financial goals first. On the other hand, investing is gradually building wealth for the long-term. This can be composed of many different strategies and types of accounts, but overall, you are putting money in the market with the goal of long-term growth. Most often, you will buy a stock, mutual fund, exchange-traded fund, or other investment with the plan to hold it for an extended period of time, often with the goal of funding your retirement. The market may fluctuate in the short-term, but that should not change your strategy, as you are investing for years or decades ahead. Diversification, a.k.a. holding a wide variety of investments within your portfolio, will reduce your overall risk to combat these market fluctuations. There are several different account types available with different tax implications. In a taxable brokerage account, which is most commonly used for trading, you pay taxes on positions when they are sold, and the amount of tax depends on how long you’ve held the position. If you sell an asset with a gain (more than you purchased it for) that you’ve held for less than a year, the gain will be taxed as ordinary income. If you’ve held the position for over a year, you will be taxed at a long-term capital gains rate, which is currently either 0%, 15%, or 20%. You may be better off starting to invest in a tax-advantaged account, such as an IRA or Roth IRA, which do not have tax consequences when trades are placed within the account. With a traditional IRA, you contribute pre- or after-tax dollars and withdrawals are taxed as income after reaching age 59 ½. With a Roth IRA, you contribute after-tax dollars and can normally make tax-free withdrawals after age 59 ½. Keep in mind, there generally is a 10% penalty for taking money out of these accounts before you reach age 59 ½. If you are offered a workplace retirement plan, do not invest anywhere else until you are at least getting your full employer match, as that is essentially “free money.” Many people do not open a taxable brokerage account until they are maxing out their workplace retirement plan and/or IRA or Roth IRA to take advantage of tax-deferred growth. If you are maxing out your retirement account(s), a taxable account is a great way to invest additional funds with money you can withdraw at any time.As we know, the media does a great job creating excitement and fear, so it is important to keep your investment strategy aligned with your goals, not emotions. Always keep your risk tolerance and time horizon in mind when selecting a strategy. Create a plan, only speculatively trade stocks with money that you can afford to lose, and make sure you understand the tax implications of your decisions ahead of time. If you need guidance, seek out a financial planner, who can help you determine your investment strategy and develop a plan to execute it.
About the author: Haley Ellis CFP® CPFA®
Haley Ellis CFP® CPFA® Haley Ellis is a CERTIFIED FINANCIAL PLANNER™, Financial Planner & Integrator for Allegiance Financial Group Advisory Services based in Carolina Beach, NC providing highly personalized financial planning and investment management services. Haley is truely passionate about financial empowerment, specifically for women and the next generation, and loves the opportunity to motivate and guide others to take charge of their financial lives. Haley can be reached at [email protected].
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