The terms “investing” and “trading” are often used interchangeably, but these two activities can achieve very different results over time. This article provides insight into these differences and may help you decide which activity suits your preferences and goals. Let’s take a look at them one by one.
Key takeaways:
- Investing is when you purchase an asset with the expectation that it will generate returns in the medium to long term.
- Contrary to investing, trading involves the frequent buying and selling of assets in the short term to generate quick returns.
- Investing is a more passive way of growing wealth, whereas trading requires a more active approach.
- Unlike traders, investors can “ride out” ups and downs in the market as their time horizons are much longer.
- In the short term, investing could be considered less risky than trading.
What is investing?
Investing is when you purchase an asset (with some sort of financial value) that’s likely to grow in value or produce future cash flow. Investors tend to hold on to assets for the medium to long term so that returns can accumulate over time.
A typical investing example is buying a house. There’s potential that the property’s market value could increase over time or generate regular income from being rented out. And because you’re likely to hold on to the investment for a while, you don’t need to worry about short-term returns.
The same applies to investments in other assets, such as stocks, bonds, or loans. When investing in a stock, for example, there’s a chance it may grow in value (or pay dividends), but seeing as you’re holding onto it for some time, day-to-day price changes aren’t that important. Here, it‘s the long-term returns that help achieve financial goals.
The long-term advantage
While returns are never guaranteed, the longer you hold onto investments, the more likely you are to ride out bad patches in the market. Globally, stock prices have grown significantly over the past 20 years, even though there have been some bumps along the way.
The S&P 500 (a stock index made up of the 500 largest companies in the US) has also risen in value over the last 20 years. A €10k investment in S&P 500 stocks in 2000 is worth €43k in 20221.
So there’s potential to earn quite attractive returns if you can ride out the slumps (and hold on during the peaks). Plus, some assets like bonds and loans produce passive income while you hold the investment, so returns come in without any effort from you.
While a chunk of your investing work is done at the beginning when establishing your asset class allocation, investors tend to check in on their portfolio performance once a quarter or so to rebalance it based on each asset’s performance. The rest of the time, your money works on its own.
The pros & cons of investing
Pros
- These days, anybody can invest! Through innovative financial technology, many investment platforms do the hard work for you – making investing accessible to everyone, regardless of their experience level.
- Most long-term investing activities are passive in nature. This means you don’t have to check in on your investments often.
- You can set investment goals to help you hold onto your better-performing investments for longer2.
- Because you aren’t actively buying and selling investments, you spend less on transaction and brokerage costs. Plus, you may get taxed less often.
- Investing allows you to continuously build a diversified portfolio which can help you reduce risk in the long term. Plus, you can practice other long-term investing strategies such as dollar-cost-averaging.
- Investing can be an effective way to stay ahead of inflation. For example, the average return of stocks over the past 10 years is around 12% (in EUR) per annum, which is higher than the average annual inflation rate3.
Cons
- Investing requires time and patience. It may take a while to see significant returns as investments can experience many ups and downs over a long time horizon.
What is trading?
Using the same real estate analogy – you can think of trading as flipping houses. You buy a house for one price with the intention of selling it for a higher price (to make a profit). Here, the goal is to take advantage of the short term change in value rather than waiting for it to grow in the long run.
The same applies to trading in financial markets. Stock traders, for example, actively buy and sell stocks and only hold on to them for hours or days. The aim: to make a profit from short-term price changes.
Although trading assets can be simple through apps (for example), it’s not always easy. Trading can require a significant amount of time, discipline, knowledge, and experience. Plus, if you already have a full-time job, trading can be tricky to fit into your daily life – as day-to-day performance matters.
The pros & cons of trading
Pros
- When trading, you can make returns quickly! Especially with leveraged (margin) trading. For many, this is why trading is more tempting than long-term investing.
- Global markets are highly liquid with millions of participants frequently trading in them. This level of liquidity offers many opportunities for traders to buy and sell assets with the click of a button.
- With trading apps and fractional trading becoming increasingly more user-friendly, anyone can start trading. And many platforms only require you to add a small amount of capital to get started.
Cons
- Financial markets can be incredibly volatile, which makes trading risky. Research suggests that most traders (without experience) end up with negative returns4.
- Because of the frequent transactions, traders pay a lot in transaction and brokerage fees. Plus, they are subject to short-term capital gains tax.
Investing vs. trading comparison
Facts suggest investing is a safer bet
Asset pricing can be highly volatile. So in the short-term, your exposure to risk as a trader is much higher than that of an investor5. Even the most experienced traders lose money. Nearly three-quarters of trades in one day can be linked to traders with a history of losses. And more than 75% of all day traders quit trading within the first two years6.
You may have seen those advertisements where millionaires explain how they went from zero to hero with a unique trading strategy. But these techniques may not work for everyone.
Individual traders compete directly with industry professionals with access to resources, cutting-edge research, and complex algorithms. And while modern investment platforms are starting to disrupt this competitive advantage, traders on these platforms are susceptible to the “herd mentality”, meaning they often follow the decisions of others4.
When investing, your timeline is much longer than a trader’s, so you have more opportunities to recover from market downturns and earn more stable returns. On Mintos, for example, market interest rates tend to fluctuate, but the longer your time horizon, the more time you have to take advantage when interest rates are high.
The bottom line
As evidence suggests, investing demands less from you than trading. Investing allows you to save time, money, and stress while your money works for you.
But just like discovering a new hobby, finding out which you prefer might come only through experience. Based on our surveys, many investors on Mintos practice both long-term investing and trading simultaneously!
If you’re just starting out and want to grow your money with long-term investing, Mintos can be a great place to start. Learn more about investing on Mintos
- (Accessed August 2022) Backtest by Curvo S&P 500 (EUR)
- Barber, B. M., & Odean, T., (2011). The Behavior of Individual Investors.
- (Accessed August 2022) MSCI World Index (EUR)
- Barber, B.M., Huang, X., Odean, T. & Schwarz, C. (2021) Attention-Induced Trading and Returns: Evidence from Robinhood Users
- Barber, B.M. & Odean, T. (2000): Trading is hazardous to your wealth
- Barber, B.M., Lee, Y.T., Liu, Y.J., Odean, T. & Zhang, K. (2017): Do Day Traders Rationally Learn About Their Ability?
