This article will focus on answering a common question. What will make you more money – trading or investing?
Trading can be quite similar to investing at certain points. For example, a trader may hold a security for the same amount of time as an investor. Therefore, to avoid confusion, I will refer to the extremes.
In this article by trader I mean someone who places trades on securities like shares or currencies for very short periods of time. This could be for as little as a few seconds or minutes.
And by investor I am referring to someone who is willing to make an investment and hold it for a very long period of time. The investment could be held for a lifetime, although a period of five to ten years is more common.
The trader focuses on profiting from short-term price movements, and cares little about the fundamentals of what they are trading.
The investor, on the other hand, focuses on the fundamentals and long-term viability of their investments. Warren Buffett is a good example of the type of investor I am referring to here. He holds investments for decades, and pays little attention to short-term price fluctuations.
At first the answer sounds simple. If you can make money in the space of a few seconds, surely that beats having to wait years.
Unsurprisingly, it is not that simple. The reason why it is not is due to risk.
Unquestionably, both trading and investing carry a level of risk. However, there is little doubt that the uncertain and fast-paced nature of trading poses a much greater risk to your capital.
For every story you hear about someone who made millions, there are thousands who lose all the money they allocate to trading. Trading can also be addictive, and there are stories of people losing their homes and destroying their family lives to feed their addiction.
There are, however, a minority of traders – estimated at around 10% – who do make a good earning out of it. Some are even able to quit their jobs and trade as a full-time career.
So for those 10%, the returns from trading could be significantly higher than from what you could make from traditional long-term investing, especially if starting with a smaller amount of money.
The world’s most famous investor – Warren Buffett – has achieved a 20% annual rate of return over the past 49 years. 20% is an excellent rate of return in investing, especially if achieved consistently and over the long-term.
But even in the highly unlikely event that you could consistently match Warren Buffett’s returns, if you started with £1,000 it would take you 38 years to make your first million.
A trader could turn a grand into a million in less than a year. For small sums of money trading has much more upside, but at such a high level of risk that most people will end up losing that sum.
There is also a very different psychology involved in investing compared to trading.
For long-term investing the primary aim is to preserve your investment, with the returns that you gain as a secondary goal.
Trading can be thought of like running a business. It is understood that you put your capital at high risk and as a result expect a larger return than you would for investing.
This is the key difference between the two.
If you already have some funds that you cannot afford to lose and you are not looking to risk it all for an uncertain higher return, then investing is the best option.
If, on the other hand, you are prepared to work hard at developing a disciplined trading strategy and accept that you have a high chance of losing any money you choose to trade with, then trading might be a better option.
The words expressed in this article are my opinion and should not be interpreted as financial advice.