Trading vs. Investing: Which One Fits Your Personality and Risk Tolerance?
Both trading and investing involve purchasing financial assets for the purpose of growing the value of those investments and either earning a profit through a sale, the accumulation of interest, or dividends paid out (and reinvested in the asset). Some of these financial instruments include:
- Individual stocks
- Bonds
- Exchange-traded fund (ETF)
- Index Fund
- Mutual Fund
What is investing?
Investing involves buying and holding a financial asset over time where the investment may grow in value. The investor hopes to earn a profit through its eventual sale or by continuing to hold the asset, earning interest (returns earned on debt investments), or being paid dividends (a portion of a company’s profits distributed to their shareholders). Investing uses a long-term strategy to try and earn a profit.
You may not realize it, but if you have a 401(k) or an individual retirement account (IRA), you are an active participant in investing. A portion of your check is invested into a financial asset like a mutual or index fund and left to grow over time. There are several benefits to investing your money in a fund. Funds are often compiled with a diverse collection of solid companies. The money, if left to grow over time, has the opportunity to grow through what is known as compounding. (see more below).
What is trading?
Trading involves buying and selling financial assets with the potential to make a profit. Traders may buy and sell investments multiple times per day, week, or month. This approach focuses on a short-term strategy with investors trying to make money fast by estimating the market fluctuations.
What is the difference between trading and investing?
As stated above, it must be emphasized that trading and investing are not the same thing, primarily in terms of the length of the investment strategy. However, one significant difference that shouldn’t be overlooked is the risk factor. All forms of investing involve risk, but trading is significantly riskier than investing. Financial professionals encourage investors to take great care and only invest the amount of money they can comfortably lose, which goes for trading and investing.
Can we mitigate some of the risks of investing?
There is no way to predict how the market is going to fluctuate. Because of this, the risk factor will always exist. However, suppose you diversify and spread your investment interests across a broad spectrum of companies and industries. In that case, if one or two aren’t doing particularly well, the others can help to balance it out. Investing in well-established companies can help mitigate some of the risks of guessing in a newer, more un-tested company or market. Your personality may play a apart your investing behavior. According to a LinkedIn study, 6 traits of “talented” investors include:
- Discipline
- Patience
- Willingness to think long term
- Adapting to change
- Flexibility
- Continuous learning
How is wealth accumulated with trading and investing?
- Trading
Buy low, sell high. The age-old strategy stock pickers have used to profit on a notoriously volatile market. That is the simple description of this risky venture. Trading involves various techniques, from short selling to futures derivatives trading, spot trading, and arbitrage trading.
It is effectively high stakes gambling with, heavy speculating, which studies have shown is far more challenging than it seems. According to a report by CNBC, 97% of all individuals who participated in trading for more than 300 days lost money.
- Investing
Long-term investing can be done with one stock or financial asset or through numerous ones. A diverse collection of financial instruments is a potentially safer approach. The idea is to hold them for an extended period of time, even decades.
What makes this type of investment more practical than trading, for example, is the ability to grow wealth through compounding. Compounding is a tip that is designed to help to make your time and money work for you. The power of compounding comes from earning returns on your principal investment and the interest you keep receiving over time.
Consult a financial professional
Due to the risk of investing in any type of financial instrument, consider consulting a financial professional to help you analyze your risk tolerance, your strategy, and how your financial decisions could impact your financial goals.
Important Disclosures:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Sources:
Trading vs investing: Which is right for you? | Fidelity
Investing vs. Trading: What's the Difference? (investopedia.com)
Attention Robinhood power users: Most day traders lose money (cnbc.com)
5 Traits of Talented Investors: What Sets Them Apart (linkedin.com)
This article was prepared by LPL Marketing Solutions
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