A confused man trying to decide between trading vs investing

Written by 11:25 am Investing

The ikigai guide to trading vs investing

About 11 minutes to read

In recent weeks – with stories like GameStop and crypto grabbing headlines – it’s clear that there’s a growing appetite for new investment opportunities. But what style suits you? What’s the best way to get started? How do you decide between the potentially quick wins of trading vs the long-term gains of investing? 

Right now, many of us are reconsidering our finances in the wake of the pandemic – we have more in savings thanks to restrictions and more time to teach ourselves the things about money that perhaps we wish we’d learnt at school. 

According to the data, the number of retail investors in the UK is up 15% from last year – a fact that has experts both nervous and excited. Excited because the average age of investors is dropping rapidly, indicating engagement from young people in a way that is absolutely unprecedented. Nervous because four out of ten new investors do not fully appreciate that high-return investments mean they might lose money too. 

It’s a tricky one though because even people who are trying to learn more about the investment world can easily find themselves running around in circles, chasing different definitions of what’s trading, what’s investing, what’s the difference and so on. In so many cases, the very terms ‘trading’ and ‘investing’ are used interchangeably. 

But there are clear distinctions between the two. 

As Edgar de Picciotto, co-founder of ikigai, explains, “Trading is about making money from the activity of buying and selling assets. Investing is about buying and holding assets. Trading is primarily about the short term, investing about the long term. There are fundamental differences on the approaches and strategies of both.”

Understanding the differences between trading and investing is becoming more and more important, especially for those of us who are new to it. 

However, if you’re trying to work out the best way to make your money work for your, then this guide is there to help: the ikigai guide to trading vs investing. A one-stop-shop to help you better understand what trading and investing are, how they differ, and whether one, the other, or both is right for you and your financial goals.  

What is trading? 

Trading is an active and short-term investment strategy. 

In everyday terms, it involves buying and selling stocks (ie. part ownership of a company) or other securities (ie. tradable financial assets) in a short amount of time with the goal of making quick returns.  

Traders are, in general, looking to profit from both rising and falling asset prices. They’re looking at the direction that an asset’s price is moving – up or down – and then trying to predict what happens next. A lot of traders find it thrilling because the timeframe for these trades is incredibly quick – sometimes meaning assets are bought and sold within weeks, days, or even minutes. It’s all about ‘beating the market’, taking advantage of short-term fluctuations in stock prices to generate greater returns than might be possible by buying and holding over a longer period of time. 

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The best known approach to trading is ‘day trading’.  This is what most of the hype has been about in recent weeks with fintech apps seeing such an exponential rise in new users. Day trading simply means that the trader is opening and closing ‘positions’ (ie. buying and selling) within a single day. The idea behind this is that if you close a trade before the market closes, then you’re less likely to suffer overnight losses. But day traders aren’t the only kind of trader, nor is their approach the only strategy. 

Different approaches include trend-following ‘position traders’, who suss out how to make fewer traders by holding onto their position for longer, or ‘swing traders’, who focus on buying assets that they expect to rise in value over a matter of days or weeks. Both of these styles are more focused on short- to medium-term gains rather than the immediate wins and losses of day trading. 

All this is to say that it’s crucial to consider the style that best suits you – especially if you’re new to trading or less experienced. You may also find it helpful to look into the different kinds of strategy out there – some rely on ‘fundamental analysis’, others look at market sentiment or technical data to make decisions. If you’ve seen or read about how social media and memestocks are an increasingly powerful influence in the trading world, that’s also because many traders are driven by the hype. Ultimately in trading, most of the time the stock itself isn’t as important as what it’s doing within the market right now. But that means you need to go deeper, form a strategy, and work out what style works best for you. 

“To be good at trading, one needs to understand the imperfections in the financial markets and exploit them at the right time,” explains Edgar. “This takes a lot of work and time. For example, an experienced oil trader would build a huge financial model taking as inputs macro- and micro-economics factors to make her trading decisions.” 

What is investing?

Investing is about the long-term. It’s a slower, more considered approach to making money off the markets.

In its simplest form, investing means that an individual will buy stocks (or other types of securities such as ETFs) and hold them for a considerable amount of time – sometimes years, or even decades. This is known as a ‘buy and hold’ strategy. 

For people who invest, the aim is to generate profits from rising asset prices. This then delivers through capital gains and dividends. Unlike with trading, nothing happens instantly or quickly – and whilst your investments can go up or down with the market, the volatility tends to be less than experienced with short-term trades. 

As Edgar explains, “The expectation with investing is that you’ll be holding the assets for years, typically for at the very least five years. There are different approaches to investing, but typically one would hold a portfolio containing multiple assets to benefit from the diversification.”

The two main styles of investing are known as Active and Passive. And there’s a lot of debate over which is better as a strategy. 

There’s also quite a lot of discussion about the definitions themselves, which can be confusing. For example, Investopedia has described active investing as about ‘market timing’, and passive as a ‘buy and hold’ strategy; whilst the Motley Fool focuses on the fact that active investing involves a human portfolio manager (whether that’s you or a professional), whereas passive investing depends on automation and roboadvisors.

Ultimately, the differences are really about how hands-on you are as an investor. 

Active Investing involves actively buying and selling securities for your portfolio with the aim to beat the stock market’s average returns. You’re essentially acting as your own portfolio manager, analysing and reading up on the individual stocks and bonds that you might want to invest in – whether that’s Tesla or Amazon or something more niche and relevant to your interests or expertise. Whilst you’re not trying to predict the tiny market fluctuations like traders are, you are looking to predict how stock values rise and actively pick the ones that will outperform.  

“Within the active investor category, you also have value investing and growth investing,” explains Edgar. “Warren Buffet is the prime example of a value investor, who will analyse companies in minutia to find the ones that are under-valued by the market (i.e. the price of the share is lower than what it should be in their opinion). They will then invest, hoping that the price will adjust over the long-run.” 

Edgar continues, “You also have growth investors. The typical examples are venture capitalists and growth funds, and as the name suggests, they invest in companies from which they expect a high growth. To do this, they also need to analyse the company in detail to assess their growth potential – because it’s not just about investing what’s already successful, that would be too easy. Good growth investors look for companies where there’s more growth potential than the market currently expects. This is how they beat the market.

Passive Investing, on the other hand, is about matching the performance of the market, or another benchmark index over time, say the S&P 500 or an FTSE 100 ETF. Rather than picking individual stocks and bonds etc, you’ll be investing in benchmark-based funds – like indexes or the exchange-traded funds that we offer at ikigai. 

“Value and growth investors have an active strategy, because they spend a lot of time analysing the companies before making an investment and then adjusting their investment portfolios over time as new information comes,” says Edgar. “Passive investing is the other side of the spectrum, with the most famous passive investor being Jack Bogle, founder of Vanguard. Passive investing is based on the fact that active investing is very costly in terms of research and transaction costs and gives room for a lot of human bias to make bad investment decisions. As such, passive investors focus on building a well-diversified portfolio, focussed on the long-term and minimising transactions.”

Like with anything, there are pros and cons to both sides. Active investing is seen as more flexible but more expensive, allowing you to hedge through short sales or put options as well as exit when stocks or sectors become too risky. Passive investing is more affordable and generally transparent, but it’ll never beat the market and investors are locked into their holdings regardless of direction. 

In both active and passive investing, the key thing is the long-termism at its core. It allows you to really think about how your money and your ambitions can align, helping you work out the best way to reach your personal goals by mobilising your finances. 

However, for newcomers to investing, then passive investing offers a strong way to get started. It puts your money to work even when you don’t have huge amounts of time to research individual stocks or bonds or funds yourself – a not insignificant thing, especially as lockdown restrictions lift and we’re able to start once again going to dinners, after-work drinks and so on. Investing passively can allow you to start small, grow your confidence, and learn before taking a more active role yourself. 

What are the key differences between trading and investing? 

When you dig into the different kinds of trading and investing, it can be easy to see more likenesses than comparisons involved. This is particularly the case with examples like position trading vs passive investing, or day trading vs active investing. After all, in the former they’re both applying buy-and-hold strategies and in the latter they’re both applying deep analysis and gut feeling on when to pivot on changing asset prices… right?

But there’s a core distinction when looking at trading vs investing. The trader is always ultimately looking to sell fast, whereas investors build portfolios in order to meet their long-term goals. 

Time and duration are unsurprisingly central to differentiating the two approaches. As discussed, trading is far more short term than investing. You can open a trading account, start trading, and close the trade all in a handful of minutes if you wanted to. On the other hand, investing is a long-term game – in order to see value from your investments, you really need to hold them for at least two to three years, with five years being a common recommendation. This is because investors will hold their stocks through the highs and lows, whereas traders will be trying to predict market movement to make quick profits.  

Likewise, the amount of time commitment needed to manage your investments is typically lower as an investor than as a trader. As Edgar notes, “Trading is very time-consuming and extremely challenging to consistently make money from it. You can get lucky but it often doesn’t last long if you haven’t put in place a solid system like a quantitative or algo-trading model.” 

Risk and reward are similarly considerations that we all need to take into account when trading or investing. All forms of investment come with an element of risk, though some are higher risk than others. However, trading is generally recognised as far riskier than investing. Why? Because trading isn’t diversified and involves a lot of speculation – quick decisions, educated guesses, and some straight-up gambles. 

Cost can be a notable difference between trading and investing as well – not least in terms of tax, particularly capital gains. Of course, this is pretty much entirely dependent on the platforms you use, the amount of trades you make, the approach you take to tax, and so on. It’s always worth checking carefully what fees you’ll be paying and what commissions or loads might exist (ie. fees charged when you buy or sell shares). It’s easy to get stung by fees, so always make sure you know exactly what you’re paying for, especially if it’s a percentage fee that may look deceptively low.

And finally, ownership. Investors tend to either buy assets outright (as in active investing) or small parts of lots of assets (like in passive investing). Traders tend not to do this, instead leveraging other financial instruments to gain exposure to certain securities, for example, through the increasingly controversial Contracts for Difference (CFDs). It’s worth noting that some of the popular trading platforms report that 76% (Trading212) or 67% (etoro) of the retail investors using their platform lose money when trading CFDs.

So is investing better than trading? 

Look, we’re a little biased in favour of investing, but neither trading or investing is inherently better or worse – just more or less risky. 

Trading is certainly the riskier endeavour. It involves a lot of speculation and without strong technical analysis and insight, it can be little more than gambling. There’s also barely any demand for diversification when trading – it’s about chasing the highs rather than trying to mitigate the lows as you do with investing – which inherently makes it riskier business. 

“Trading gives thrills,” says Edgar, “It’s like an evening at the casino. But if that’s the case, it should be considered as a hobby – and not as a way to grow money.”

But then trading might mean higher returns. As Business Insider explains, “Investors may hope to earn 8% to 10% on their portfolio per year. But a trader may hope to earn that much or more per month. Even traders who earned “just” 5% per month would end up with an uncompounded annual return of 60%.”  

Investing, on the other hand, is a more sure-footed, considered way to approach the stock market. As we said earlier, passive investing can be a great introduction to the investment space as well as a strong way to grow your wealth over time. 

“Investing is how most people can grow their savings,” says Edgar. “Of course, you’ll find proponents of both active (growth and value) investing and passive investing. At ikigai, we believe in passive investing as a way to obtain returns from the market over the long-run by investing in a well-diversified portfolio. It’s an investment philosophy that minimises costs, but also your levels of stress as you just invest, hold and avoid looking at it too much. There’s no mystery why it’s the main investing philosophy shared in the FIRE community.  As Jack Bogle says: “Don’t look for the needle in the haystack. Just buy the haystack!”

What makes sense for you? 

When it comes to making investments – especially if you’re just starting out – it’s important to ask yourself why you’re looking to invest. 

Whilst interest rates are at a post-pandemic low, investing and trading come with risks – not least the potential to lose everything you’ve saved. 

For investors, this means that even though stocks and shares have historically outperformed interest rates on savings accounts, there’s no guarantee this will always be the case. For new traders, the consideration might be that with the future still feeling uncertain, right now isn’t the time to speculate. Similarly, you may decide that your circumstances don’t lend themselves to either investing or trading right now, because of credit card debt or expensive mortgage payments or a lack of secure savings. 

But if you’re one of the many people who managed to save in recent months or you’ve just received a bonus or you’ve made a plan and want to now put your money to work, then the crucial thing is to approach your decision mindfully. This means considering your circumstances (ie. what you have in the bank, your job security) as well as your relationship with your money (ie. what’s your risk tolerance, how financially resilient are you) and what the opportunities out there may be

After all, if you’re in your early thirties and want to boost your retirement pot or to grow your wealth more broadly, then the longer-term approach of investing may naturally appeal more than a riskier trading strategy. But if you have the time and desire to dedicate to a short-term plan, then well-researched and monitored trading might help you get there faster. 

For new investors, Edgar emphasises that it’s about starting small and growing your commitment as you gain confidence and insight on how investing works. 

“Start with a platform that allows you to put a small amount in to start testing – this could be £500, £50 or even £1 – whatever you’re comfortable using. Then check out that the fees are correct and wait for a while. See how it feels to have your money invested,” he says. “Consider adding more money over time as you get comfortable. But be careful to not invest more than your financial situation allows. This is especially important in the current environment where market movements remain uncertain post-pandemic.”

Edgar also notes that it’s essential not to put all your money into investments, even now when interest rates are poor. “The golden rule is to keep a safety net in cash equal to three to six months of your monthly outgoings,” he says. “This will act as a financial cushion should markets collapse or investments perform poorly.” 

Working out what’s right for you may depend on how your money, values, and commitments align (check out our handy blog on mindful money here). Once you know this, you can choose the best style and platform for your goals. For example, you may decide that right now it’s better to start with a passive investing platform to ease yourself in, or if you’re a little more experienced, prefer to take this moment to start learning more about value or growth investing strategies. 

When it comes to trading vs investing, it’s also not really a matter of either / or – you can do both concurrently. You may decide that you want to start investing by having 70% of your savings in a long-term investment portfolio or an ISA, whilst keeping 20% for an emergency fund and 10% to put into trades.  

At the end of the day, you should never invest what you can’t afford to lose. Stock markets can crash, opportunities can disappear, and you could lose a significant chuck of your wealth in the case of things going wrong. However, it’s worth noting that with long-term investing, you’re far more likely to be able to ride out the market bumps than you are with short-term trading styles. 

We can’t tell you whether investing is right for you. But if you’re going to start investing, it’s important to be aware of the risks as well as the possibility for reward.  

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We built ikigai specifically for those who want to bring their lifestyle to the next level, by taking better care of their finances.

ikigai beautifully combines wealth management and everyday banking in one single app. And by doing so, it creates a whole new world of opportunities.

Visit https://ikigai.money to find out more.

Maurizio & Edgar, Co-Founders, ikigai

When investing, your capital is at risk.

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Tags: , , Last modified: 24 August 2021