Should You Trade Or Invest – Comparative Analysis
Which is more profitable – trading or investing? Who makes more money – traders or investors? The short answer is that you can get rich quickly by short-term trading, but you are more likely to make money by long-term investing.
A good trader can make a lot of money, but most traders lose money. Most long-term investors get a decent return after some decades, but you are unlikely to get filthy rich. However, the odds of a positive outcome are much higher for long-term investors. Most leveraged short-term traders fail, while most un-leveraged investors prosper. Thus, most are better off by investing than trading. Trading requires skillsets that differ substantially from investing.
Trading vs investing:
Trading is attractive because you can make a lot of money in a short period of time. Trading is scalable. Scalable means something that can be easily expanded, thus more profitable.
However, you must have in mind that you are more likely to hear more often about successful traders than unsuccessful traders. We ignore or forget the effect of survivorship bias: we focus on the winners, we rarely care about the losers. As scale increases, so does the survivorship bias.
Trading is a game of binary outcomes: you either become successful (and rich), or you end up losing. The winner takes it all effect is much more dominant in trading than in investing. Most traders lose, only a few make a lot of money.
Investing is different- there are much less binary outcomes. A dentist can serve as an example of an investor. A dentist makes 300 000 USD a year with little variation and randomness. The dentist works a fixed amount of hours and thus has a limit on how much money he can make. The profession is not scalable – but the outcome has a much higher possibility of being positive.
The ecology of the markets
Most traders fail and end up losing money. Even worse, this doesn’t factor in the lost opportunity costs for spending your capital in other ways, for example investing. Just a tiny minority of the traders end up making a decent amount of money. We guess this number is around 1%.
It makes perfect sense that just a tiny fraction of the trading community is successful. Why?
Because trading doesn’t create any wealth. It’s a zero-sum game in the short-term, even for stocks. Just like all poker players around a table can’t win, so can’t all traders make money. Someone has to be the prey for the predators. Make sure you both understand the trading game and yourself. What is the market? Who are the competitors? What is your trading edge? In order to succeed as a trader, you both need to work hard and be adaptive to the ever-changing market cycles.
Compare this to investing: you don’t need to work hard and you don’t need to be smart. You can just invest in active and passive mutual funds and do absolutely nothing. In the long-term, the stock market is not a zero-sum game. The stock market creates wealth that is distributed to all owners – the shareholders. This is something you don’t participate in when you are a short-term trader. Additionally, you have a second tailwind: the FED keeps printing money and stocks have served as a good inflation hedge over the last 100 years.
Being an investor you only have to make sure you are diversified and patient. This way you can build wealth with a high probability of success. Unfortunately, this is not very exciting and takes a lot of time.
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The magic of time and compounding:
The advantage of investing is that you can let your capital compound. For example, if you invest in a diversified mutual fund, you can just put the shares/units in the drawer and more or less forget about it. The chances that you have a decent nest egg after 15-30 years are pretty high. The time you spend compounding is much more important than the amount you invest and save.
If you consider trading, please have a look at the chart below:
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