Investing often sounds like a get-rich-quick game.
I’m sure you’ve heard of the folks who suddenly got rich by investing in Bitcoin, or those who hopped on the GameStop train and made hundreds of thousands of dollars seemingly overnight.
At the end of the day, this isn’t investing. At least not responsible investing.
Let’s talk about long-term investing vs. simply trading stocks to make a quick buck. One (and I’m sure you can guess which one) will almost always offer way better results than the other.
What is active stock trading?
Source: Giphy.com
When I say “stock trading” I am referring to active stock trading. This is the act of buying and selling stocks (or stock options) with the intention of capturing a short-term profit.
You might be trading stocks multiple times a day (so-called day trading), a few times a week, or even a few times a month. Opinions differ, but I think you’re “trading” if you don’t own the stock for more than a year.
Stock market volatility makes stock trading possible.
We’ve all seen stock tickers on websites and TV. The prices of individual stocks change throughout the day based upon countless factors including world events and company-specific news. The price of market indices (e.g. Dow Jones Industrial Average, S&P 500) move according to the prices of their component stocks.
Stock traders pore over news looking for intelligence they believe will allow them to predict which direction a certain stock (or entire indices) will move on a given day. Of course, making a profitable trade depends on many more things than a bit of intel. If winning at trading were as easy as reading that Peloton shipped more bikes than expected, buying the stock, and then selling it at the end of the day, I’m not sure why anybody would go to their day jobs.
What’s wrong with stock trading?
Nothing is wrong with stock trading as long as you recognize it for what it is – entertainment – and act accordingly.
Stock trading has more in common with poker or sports betting than it does with investing. It’s speculative. Despite what they’ll say, most traders’ results have more to do with luck than skill.
Stock trading, like poker, is a zero-sum game. When you make money, someone else loses money. And vice versa. Interestingly, the same is not true for investing (more on that in a minute).
The thing about zero-sum games is that you don’t want to play them unless you can be absolutely sure you are going to win at least 51% of the time.
Just think about the fact that every time someone trades a stock (in the short run) somebody else is on the opposite end of that deal. Each time you make a decision to buy or sell shares, there’s somebody in the world who believes going the other way is the better play.
The biggest argument to steer clear of trading is the fact that you’re playing the game with smarter people with vastly more resources:
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- More brains (hedge funds employing Ivy League MBAs).
- More capital (billions!).
- Faster tech (their trades are done before I’ve even pulled a quote).
- Better intel (they have their sources).
If you’ve ever watched the show Billions, you know what I’m talking about.
I hate to tell you this. But unless you have a very good reason to believe you can beat Wall Street’s best players, you are going to lose money trading stocks in the long run.
What is investing, then?
Gambling is to trading stocks as gardening is to investing.
There’s a famous quote by Nobel prize-winning economist Paul Samuelson:
“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
To most, gambling isn’t boring. By contrast, some find gardening pleasurable (and not boring). But I don’t think anybody would call gardening exciting.
Good investing is exactly like that. It doesn’t have to be 100% passive. You can enjoy following economic trends, looking for opportunities, and adjusting your allocation. But successful investors do these things slowly and methodically.
Read more: Asset Allocation For Young Investors
Investing takes time
Sometimes, I get emails from readers that go something like this:
“I read your article on how to start investing last week. I bought $100 of this stock and have already lost $5. Thanks for nothing!”
Did they even read the article? Probably not.
If you think you can just buy a stock and watch your money just grow and grow and grow, you’re going to have a bad time.
It’s entirely possible you could put your money into a very responsible investment like a total stock market index fund and lose 10%, 20%, or even 30% of your money tomorrow, next week, or next month. It’s not likely, but it’s possible.
But you haven’t actually lost that money unless you panic and sell your position. Investing is a long-term game. The longer you’re in it, the better you’ll do.
If you look at historical rolling 30-year returns of the S&P 500 going back to 1926, the worst average annual return over any single period was 8%. This was if you invested at the height of the market just before the Great Depression. For most other periods, your average annual returns would’ve been between 10% and 13%.
Past performance may not be indicative of future results. But over a three-decade period, the S&P 500 hasn’t let anyone down yet.
Read more: How To Invest In The S&P 500
Trading is harmful to your wealth
There’s a popular quip among investors that goes:
“Time in the market beats timing the market.”
Studies from The Journal of Finance (and countless others) show time and time again that active trading doesn’t pay off for average investors.
Well, what about Wall Street? Perhaps individual investors can’t get ahead with active trading, but surely this is why hedge funds exist, right? Warren Buffet’s famous (winning) $500,000 bet with hedge fund managers that they couldn’t beat the returns of the S&P 500 over 10 years casts doubt on even this.
The simple truth is that the longer the time frame, the more difficult it is to beat the average return of the market. The number of professionals who can prove they’ve beaten the total return of the S&P 500 over 20 or more years is embarrassingly small.
If this is true, why are there investing professionals anyway?
Why do major banks have trading desks and hand out six- and seven-figure bonuses to their staffers there? Several reasons:
- They have different objectives. They’re thinking short-term, not long-term. They’re making trades to hedge other investments. They’re aiming to reduce volatility or create a steady income. They have many reasons to trade that actually aren’t about long-term returns.
- They have suckers for customers. A large percentage of people will never stop to investigate their money manager’s long-term performance – they’re just concerned about this year.
- They need to justify their existence. It’s hard to charge clients 1% or 2% of their assets every year if the firm is just parking the client’s money in index funds.
- Finally, a very small percentage of them do make money.
History and research prove that your best shot at good long-term investment returns comes from owning the entire stock market and sitting tight for a decade or more.
Is there a small chance you could find a money manager to do better (or even do it yourself)? Yes, a small one. But, when you consider the probability you will pick a winning manager (or win at market timing yourself), you’ll be better off buying and holding every time.
Investing requires patients and discipline
Source: Giphy.com
Let’s go back to the gardening analogy. A tree does not grow overnight any more than my impatient reader’s money doubles overnight.
If you want to grow something, you plant a seed and water the soil a little bit every day. Then, you wait.
If you want your money to grow, you seed your account and deposit a little bit more every year. Then, you wait.
There will be times when things don’t look so good. There will be setbacks. The economy will sputter and the market will crash. Nevertheless, stay the course.
If you have a vegetable garden and rabbits eat all the carrots, you wouldn’t tear out the tomatoes and cucumbers and just give up.
As an investor, you must not give up when there are down days (or months or years).
Panic selling is a dangerous game. Nobody knows when a bear market is going to hit bottom. Too often, investors who panic-sell wait too long to sell and wait too long to buy back in. Therefore, they get little benefit from selling because they miss the market’s best days on its recovery.
Read more: Bear Market Vs. Bull Market: How Can You Tell Which We’re In?
Of course, selling and buying back in during a crash can work, but only if you get the timing exactly right. And nobody has a crystal ball. If the hedge funds can’t always do it with all of their resources, don’t think that you can!
Be patient. Stay the course. Invest your money and get on with life. You’ll thank me in 30 years.
Is it ever OK to trade?
While actively trading stocks can be fun, good investing is boring. It should be boring.
But what if you like trading? For the fun, the education, and – yes – even the rush?
It’s perfectly OK to trade. Open an account at Robinhood, or TD Ameritrade, or another broker and trade away.
But if you want to be smart about it, just follow my three rules:
- Treat trading as entertainment/education, not as investing. In other words, expect to lose money.
- Never borrow money to trade (no margin).
- Never trade with more than 10% of your net worth.
Read more: Best Online Brokerage Accounts For Beginners
Summary
Stock trading is not investing.
Trading is speculative, exciting, and short-term. Investing is methodical, boring, and long-term.
The advancing technology in stock brokerage apps makes buying and selling stock so easy that it can feel like a game, not real life.
Go ahead and trade if you want to, but treat it as entertainment. Set a budget and stick to it.
Meanwhile, learn how to be a dedicated and sober long-term investor.
Start small if you need to, but put your money to work. Then, forget about it until you’re old.