Trading vs investing: 4 key differences

Trading vs investing: 4 key differences

Learn the key differences between these two investment styles to see which one is appropriate for you

Olga Rabo

Apr 27, 2021

·

10

min read

Trading vs investing — what’s the difference?

If you ever found yourself asking this question, this post is for you. If you have never asked yourself this question and thought that trading and investing are the same thing, well then, this post is for you too. Truth is, while trading and investing are often used interchangeably, these two methods are considerably different in their nature.


The Speed Read:

1. Investing is a long-term game, while trading is optimised for short-term profits

2. Trading can be an emotional rollercoaster, but investing rewards those who are patient

3. Long-term investing historically pays off

4. Investing has lower transaction costs and potentially offers tax advantages in some countries

1. Investing is oriented towards long-term profit

While trading and investing share the same goal — to increase the capital invested through generating financial returns — each style is suitable for different kinds of people.

Traders are a subgroup of investors: both use the same mechanisms, with the difference being in timelines and frequencies of buying and selling. Traders are all about making frequent transactions with the goal of “beating the market”. Investors, in the meantime, live by the old adage: “Time on the market beats timing the market”. In short, trading focuses on short-term buying and selling, while investing focuses on long-term buying and holding.

Think about it this way:

Two people sign up for a race. One runs at a consistent, comfortable speed throughout the run all the way up until the finish line. The other person goes in bursts of sprinting, alternated with periods of walking. The first person is a jogger — the second one is a sprinter. Just as sprinting and jogging are two different forms of running, trading and investing are two absolutely different forms of growing capital by taking advantage of the financial markets.

Depending on your level of market expertise and the time you can spend participating in the market, trading can be very effort-demanding and time-consuming. You have to constantly stay on top of the stock market: some traders buy and sell a stock within minutes.

Why?

Because stock prices fluctuate literally every single second — so your timing has to be really spot-on to use the short windows of opportunity.

In the meantime, investing is all about having long-term goals. While “invest and forget” shouldn’t be taken too literally (you should, after all, tweak your portfolio once in a while to make sure it’s well-diversified), patience is a virtue when it comes to investing.

Successful investing strategies tend to develop over the long run, and often, as an investor, you may need to wait years to realize the best potential returns. In the case of investing, time means money, quite literally, due to the compound interest (the interest earned on the interest earned).

If your €10 investment earns you 20% interest in a year, the following year you’ll earn 20% on €12, and the year after — 20% on €14,40. It’s always compounding and accumulating, so the longer you stay in, the more you can capitalize on the interest. Without even adding to your initial capital, compounding allows you to gain continuous reward, growing year after year.

Of course, annual returns can fluctuate and there’s never a guarantee that you’ll have a positive return every single year. It is important to understand that the market is volatile so it’s normal for your portfolio to go up and down.

2. Trading can be an emotional rollercoaster

Remember when Phoebe from Friends became a stock broker? She was a day trader, which came with the kind of stress she couldn’t really handle.  

There are four different types of traders:

Long-term investors, on the other hand, can hold assets for as long as 30 years or more. Normally, long-term investing is often thought to be in the range of at least 7-10 years of holding time (although, of course, there are no absolute rules). In comparison to trading, long-term investing doesn’t require as many resources — which makes it perfect for less experienced investors.

For many, trading is just too stressful. As mentioned above, staying on top of market fluctuations is mandatory, and, truth be told, trying to outbeat the market can be a thankless job given the amount of stress it can induce. When you’re trading, it’s hard to time when to get in and out of the market. For investing, timing doesn’t matter so much if you hold investments for a longer period of time because the short-term volatility weathers out.

It’s very difficult — and risky! — to try to time the market. Many people tend to panic when they see the share falling. So trading isn’t well-suited if your emotions get affected by news headlines signaling a downturn, for example, as you might be tempted to sell when, instead, you should be holding — or buying. Making investment decisions based on emotions can be detrimental to your portfolio — so keeping your eyes on the prize and riding out the short-term gains in favour of long-term returns is just a calmer thing to do.

The best advice (that’s not an investment advice)?

Keep calm and, literally, carry on.

3. Long-term investing historically pays off

History shows that staying invested in the market over the long term pays off. The world’s economy is growing overall, and the stock market reflects that like a mirror.

Take S&P 500, for example (which stands for “The Standard and Poor’s 500”): a public float stock market index of the 500 largest companies listed on stock exchanges in the United States.

If you invested $5000 in the S&P 500 at the beginning of 1988, you would have about $161,569.55 at the beginning of 2021, assuming you reinvested all dividends each year. That’s an annual return of 11.1064%:

Total return analysis for S&P 500 1988-2021. Source: Bloomberg
TOTAL RETURN ANALYSIS FOR S&P 500 1988-2021. SOURCE: BLOOMBERG

Another example? Take a look at Germany’s DAX 30. This slightly more “boring” market doesn’t boast tech giants like Amazon, Facebook, or eBay, so its growth has been slower. Still, had you invested $5,000 in the DAX back in 1988, you would have accumulated $73,401.93 over this period of time. This is an annual return of about 8.4815% per year.

Total return analysis for DAX 1988-2021. Source: Bloomberg
TOTAL RETURN ANALYSIS FOR DAX 1988-2021. SOURCE: BLOOMBERG

The market is volatile, and it always goes up and down.

But it’s important to note that short-term volatility is not necessarily indicative of long-term results. The stock market can be highly volatile on a daily basis, but show long-term patterns of growth and stability. This is why “buy and hold” is such a solid investment strategy: you can still generate significant returns without needing to follow the market on a daily basis. Because of that, when it comes to trading vs investing, it doesn’t really matter when you “enter” the market if you invest, whereas if you trade timing is absolutely crucial.

4. Investing has lower transaction costs

When it comes to trading vs investing, there’s one thing that’s clear: the transaction costs of being an active trader will affect your returns in the long term. When you trade, you’re moving money in and out all the time. Popular trading apps, like TradeRepublic, for example, still charge €1 every transaction made, so serious traders have to trade in big volumes in order to make a profit to cover up the transaction costs.

While €1 sounds like a small price to pay, even if you lose 1% of your portfolio value due to commissions and fees each year, that could eat away a very sizable chunk of returns over time. Remember compound interest? Costs can compound over time, too — but this time, not in your favour.

Putting your money into long-term investments could also provide tax advantages on capital gains — at least if you’re in the US where long-term gains are taxed at rates below your income tax bracket and short-term gains are taxed as if it’s your regular income.

In Germany, for instance, capital gains on shares are taxed at a flat 25% irrespective of how long they are held (which is much lower in comparison to the income tax of up to 42%) . In Latvia, capital gains are taxed at a rate of 20%, but redistributed dividends aren’t taxed at all (so it makes sense to hold your securities for longer). This is how some regulations in the EU are encouraging long-term investing rather than frequent trading.

Trading vs. investing: which one should you be doing?

Fact: the longer you invest, the more likely you’ll be able to weather low market periods and survive the risks of losing money. This speaks on behalf of long-term investing, when compared to trading, which is generally more arduous in nature. Depending on your personality, you might opt for trading vs investing — given, of course, you’re more stress-resistant than Phoebe from Friends, can truly understand and follow the market continuously and are ready to invest not only money but also time. For others who want to avoid the risks and the stress, long-term investing can be the ultimate safe haven for managing capital the right way.

Ultimately, the choice is yours.

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