Should You Trade Or Invest?

I sometimes receive e-mails from potential traders that want to get “rich” trading. I tell them to instead consider investing their capital for long-term appreciation, preferably via passive or active mutual funds. This is why:

The magic of compounding.

The chart shows 10 000 invested annually for 30 years with 9% return: after 30 years you have almost 1.4 million in assets. Not bad! Of course, this is a long time to “wait” and additionally the return is not guaranteed. However, the graph illustrates why most people should invest, not trade:

Most leveraged short-term traders fail, while most un-leveraged investors prosper.

This is not anecdotal evidence. Let’s look at some evidence from research done on this topic:

  • Most short-term traders end up losing money, not making money. If you invest in a mutual fund, you will most likely make money over a ten-year horizon (depending on valuations, of course).
  • Short-term trading involves spending a lot of time trading and doing research. Trading is a job. Opposite, if you invest in mutual funds the capital works for you while you make money in a regular job.
  • Trading involves stress, both mentally and financially. Investing in a mutual fund does not involve much stress (buy it later “forget” it). Women are better investors than men simply because they buy and keep/”forget” their mutual funds. Men have a stronger urge to outsmart the market by buying and selling, which usually fails.
  • You risk wasting you best years. Most traders are between 20 and 35, the years where you can improve your professional career. It’s not easy getting a job after 10 years as a trader and certainly not with mediocre results. In order to keep trading as a job, you need to make more money than in a regular job to offset the risk.
  • Most traders take a lot of risk and just a few bad trades can ruin your finances (leverage often leads to ruin). Traders underestimate the sequence risk of ruin.

Failure of self-control leads to overtrading and mediocre results. Furthermore, we tend think we are more clever than we are. Self-directed traders and investors perform worse than funds, according to research. In other words, by trying to be smart, you risk ending up being foolish. Markets are highly complex, and it’s extremely difficult to make a good timing of both buying and selling. Women are better investors quite simply because they are not trying to be smart. A simple saving plan where you force yourself to invest at certain intervals are the best and most simple way to do it.

 

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