Trading Vs. Investing

Note to readers: I originally wrote this article for The Div-Net, and published it on February 2, 2012. But I never re-published it here and after going through some drafts I thought I would publish it here as I think the ideas are timeless. 

There are many ways to make money in the stock market. There are a lot of pundits and followers of different strategies that would have you believe that they have a magic way to exploit the market for extraordinary profits with minimal work and time. Every time I read claims like that, I ask myself: “If it was so easy, and it makes you rich so fast, why are you busy writing articles instead of making millions of dollars?”. Believe me, if someone has a “secret” that makes tons of money in a short period of time they’re not going to share it with the world.

This leads me to the concept of stock trading. To me, stock trading is basically buying an equity with a short-term time horizon with the plan of selling it at a higher price in the near future. You are essentially trying to buy an asset with the hopes that you can quickly turn it and sell at a higher price to a sucker down the line. This is akin to gambling, in my view. There are day traders, who try to close buy-and-sell transactions in the same trading day. There are swing traders who try the “buy Y at $X and sell at $X+” game, and try and sell Y within days, weeks or even a month or two. Make no mistake, however, these are not investors. These are traders. They are trying to exploit an inefficient market by buying an equity at a distressed price and quickly make money on that equity. They try to repeat these transactions over and over again until they make significant profits. Traders are speculators, not investors.

There are a number of reasons that I don’t actively trade. First, I can’t predict the future. If I buy stock Y at $50, I have no idea if it will be worth $51 tomorrow or $48 tomorrow. Because of my inability to predict the future, I don’t buy assets with the plan to quickly sell for a profit. There are analysts and money managers that try to follow trends and predict the way the stock market is going to react to certain news. Some of these money managers are paid millions of dollars to do this. Yet, I read countless articles about money managers that under-perform the general market. When you are actively trading in and out of positions you must remember that you are incurring taxes on capital gains and you are also incurring trading fees on transactions. I can see how taxes and fees could quickly erode any profits one would make with day trading or swing trading. In addition, you have to keep in mind that you are going to incur losses unless you’re Nostradamus.

The main reason I don’t trade, however, is that I’m an investor first and foremost. I believe the stock market is a wonderfully efficient platform for an average Joe like me to take my middle class income and invest with some of the biggest and best companies in the world. I like to invest with quality companies that have a history of rising earnings, revenues and dividends. I invest with companies that have an economic moat, economies of scale, large distribution networks, brand name products that people want and/or need. I invest with companies that can raise prices on their products at a percentage that exceeds inflation. I invest with companies like Johnson & Johnson (JNJ), Philip Morris International (PM) and Coca-Cola (KO) because I believe that they do an excellent job of making money and I believe that over the course of many, many years they will grow my investments many times over.

Stock trading is relying on your ability to forecast the future, stock trends, market efficiencies and your chances at selling your asset for a higher price in a short period of time. Many people have thought this was the true path to riches, and many people have failed. I’m not saying that day trading or swing trading can’t make you money, but I don’t believe it’s the most efficient or reliable way of doing so. It’s speculating. You could go to Las Vegas and double your money tomorrow. But how repeatable is that?

I like investing. I like putting my chips on major, multinational companies and letting them churn out profits over decades. They pay me dividends to invest with them, which I use to reinvest into my portfolio. Those reinvested dividends then accumulate additional shares, which then pay out larger dividends and this repeats itself over and over again. This is a reliable, repeatable and true way to build wealth over time. It’s not speculating, it’s not trading, it’s not gambling and it won’t make you rich over night. But, I believe for an investor who can spot value, is willing to be patient and who knows quality when they see it one can slowly build their wealth over time.

Keep in mind, however, that there is a difference between buy-and-hold and buy-and-monitor. I’m an investor of the latter type. I’m not saying that a long-term value-oriented dividend growth investor should never sell shares of a company. It’s important to always monitor your investments and keep an eye out for any changes in a company’s fundamentals. For instance, I spotted some changing fundamentals in one of my investments, Telefonica S.A. (TEF) (ADR) recently and I sold my shares because I believed the dividend was not sustainable. The dividend was cut a week later. It’s important to keep a checklist of when to sell a dividend growth stock.

All in all, a speculator could make money trading in and out of the stock market. Trying to buy stocks at one price, just to sell in quick order at a higher price is simply not a game I’m willing to play. I have a full-time job and I have other things to attend to, and things I’d rather do than fret around my computer waiting for the right price to come. I’d rather invest my money for the long-term with excellent companies that are wonderfully proficient at making money and paying me dividends. The share prices of these companies naturally rise over time because these companies are efficient at increasing earnings and revenues, so their market cap naturally follows as more investors pile money into these companies’ shares. I like investing in appreciating assets that rise in value over time, that also provide cash flow until the time comes to sell those assets, if ever.

What about you? Do you execute a trading strategy at all?

Full Disclosure: I’m long JNJ, PM, KO.

Thanks for reading.

Comments

  1. says

    Great article DM. A great strategy for me has been simply sticking with dividend champions and monitoring payout ratios.

    Like you, I always am conscious about what I spend my money on and look for ways to cut the spending. Lowering my personal monthly costs gives me more discretionary spending dollars for investing, and lowers the amount needed to truly retire from my job. I really don’t need 4000 dollars each month to have food and sleep!

    • says

      Investing Early,

      I absolutely agree. One definitely does not need $4k/mo to retire on unless they’re completely obtuse when it comes to managing expenses.

      You nailed it on the head though. Managing expenses bridges the gap between now and retirement two-fold. It allows more capital for investing, which can compound at a faster rate. It also brings the finish line closer because you don’t need as much capital to live on.

      Best wishes!

  2. says

    I definitely think that investing dollars needs to make up the majority of one’s portfolio. Although a little trading/speculating doesn’t hurt if it keeps you more interested. As long as you don’t allocate more than 10% and then keep taking money away from investing dollars to trade with if you lose that 10%. DGI can be a long ride til you truly see results so anything that can keep you focused is good for me. Great post!

    • says

      Passive Income Pursuit,

      I agree with you on the thought of DGI taking a while to show progress. I’m not opposed to 10% of one’s portfolio being allocated to speculating…but it needs to be understood that it’s speculating (gambling) and nothing more or less. If that 10% won’t affect your long-term goals, then I guess you can go for it.

      Personally, I like every penny maximized and growing with companies that will give me a high ROI.

      Thanks for stopping by!

      Take care.

    • says

      I’m definitely focused on DGI. I’ll be glad when the new year rolls around and I can start unloading some of my ESPP shares to buy more DGI stocks. I have about half the position that I can start selling as qualifying dispositions Jan 1 which is good. If the market is flat between now and then I’ll have about $6500 to sell off and put to working better for me.

  3. says

    Great discription of the differenece between investing and trading DM. I’m with you on being an investor and not a trader. Deciding on whether you are a trader or investor is, in part, a reflection of your nature. Some people could not follow the path of DGI no more than we could become day traders. I’m thankful for these differences, as it takes all types to make a market. As for me, I’ll keep following the DGI method.

    • says

      The Stoic,

      One’s temperament and patience level probably does have something to do with whether they are an investor or trader.

      Personally, I find the thought of reliance on Mr. Market’s bi-polar moves upward and downward being the sole provider of wealth creation for myself nerve-wracking and crazy. Other people find it exciting. Maybe I’m boring?

      Being easily entertained makes it easy to keep my expenses low, I suppose! :)

      Best wishes.

  4. says

    Hmm, maybe you are Nostradamus you were right about TEF!

    As you know I’m an investor and not really interested in trading. I’m starting to realize that I’m more of an income investor than just a dividend growth investor. It’s just that right now bonds and interest rates are so low that I can find better yields and better investments in stocks. One day the opposite will be true and I won’t hesitate to buy bonds. When my dad was my age he could buy U.S. treasury bonds paying around 10%. Who would say no to that?

    • says

      CI,

      Haha. Maybe I’ve got a little Nostradamus in me! Actually, selling before the dividend cut was about the only thing I did right with TEF. I should have never invested in the first place.

      Nothing wrong with being an income investor. I would certainly be open to having up to 20% or so of my portfolio allocated to very long-term bonds (30y T) if the price (yield) is right. Unfortunately, we’re nowhere near that level right now.

      I hope that right about the time I’m planning on retiring, or at least working less, that yields will be very attractive on long-term bonds and I’ll start buying them up in droves. At 40, a solid yield on a 30y T will be paying me until I’m 70! Of course, the downside to that is the capital returned to me at 70 will be worthless. That assumes I’d hold to maturity.

      Best regards!

  5. says

    I have to admit I am 90% investor and 10% Speculative with my Portfolio.

    I like the fun and Risk Reward times with the 10%.

    I guess i am also converting my hobby into a business 10% of the time too for the same reasons.

    • says

      FYC,

      Nothing wrong with that. Like I commented earlier, as long as you are honest with yourself and don’t get upset if the 10% causes losses then it’s okay. I’m personally looking to reach FI as soon as possible and I’m trying to make every dollar work for me the best way I know how.

      Of course, if your 10% turns out to be a home-run that can get you to FI even closer. That’s the fun of it that you speak of. It’s like the other 10% being a little lottery. It can certainly spice up the portfolio, but of course it can also cause you to lag behind your goals. Just be careful.

      Take care.

  6. says

    I’m an investor too but I have some rules concerning the selling of stocks.
    Because since dividend stocks give you a revenue, you need to have a good reason to sell and receive a return at least equivalent to one full dividends year, it’s useless otherwise. And the cash + return of the sell must be reinvested in short term in better dividend stock, because after all we do it to generate a revenue too.
    That’s my 2 cents of rules but anyway it helped me to optimize the portfolio.

    • says

      JF Baconnet,

      Thanks for stopping by and adding that.

      I agree with you. If you’re going to sell a dividend growth stock, you’re not only losing rights to the dividends and income that provides, but also losing the rights to future growth of that income stream. So, one should have an opportunity that much greater to invest in with the capital from the sale. Always important points to consider.

      Best wishes!

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