When it comes to finances, financial planning and financial health, there are a lot of terms thrown around – some are used correctly – while some are used incorrectly or interchangeably, when they, in fact, have very different meanings. That’s why we want to take a closer look at two common terms that are sometimes used as if they mean the same thing, but which are actually quite different.
We’re looking at the difference between “trading” and “investing.” Even if you think you’ve got this one down, read on to make sure that you’re using these two correctly.
Jamie Hopkins, managing partner of Wealth Solutions at Carson Group and author of the book “Find your Freedom: Financial Planning for a Life on Purpose,” says that these terms are often used interchangeably but, they are, in fact, very distinct. It’s possible to be very good at one while struggling with the other.
Investing
Hopkins defines investing as “putting money aside for a return on your investment.” Investing can range in risk, timeframe and purpose. Sometimes you might want to invest in a specific company or area to drive a specific outcome. In other cases, you invest for a specific timeframe of cash flow, perhaps a bond ladder or a cash-like account that you need soon, or you might invest in the market for your retirement and take on more risk because you are looking for a better long-term return and have a long time horizon.
Trading
Hopkins defines trading “as the process of moving your investments from one to another.” He says when most people talk about trading versus investing, they are actually talking about short-term versus long-term. For instance, day trading is the process of selling and buying lots of investments in order to achieve a gain by timing the market or finding unpriced investments or investments gaining short-term momentum. Investing, done well, is less about market timing or gaming the system, but instead looking for long-term value, being patient and knowing why you are investing.
Saving
Who mentioned saving? This third term is often used alongside investing and trading to mean the same thing, but Hopkins defines this, simply, as “spending less than you make. Saving is what happens when you budget correctly and keep your expenses lower than your income.”
Which one is better?
For Hopkins, day trading can be risky and has the potential for losing you a lot of money quickly. It’s easy to get behind and lose sight of your strategy.
“This is a profession and a job,” Hopkins said. “I warn people against trying to hop into someone else’s career and try to compete part time. Most people should not become day traders or believe that they will increase their returns by trading more. Research shows that people who trade more frequently have lower returns overall.”
He prefers for people to focus more on investing, which should relate less to your age and income and more to your desired outcomes. “This includes incorporating your values into your investment philosophy,” he says. “There are 50 year olds with 40-year investing timelines and 30 year olds with 15-year investing timelines.”
He tells people to first set their long-term aspirations and core values and consider who they want to be and what they care about. Then, investment (and spending) goals that align with this can be set. This may mean taking lots of risks in the market or in private investments, but maybe not.
“Generally, when you are younger you have more time on your side, so you can take on more risk with your investments,” he says. “Typically, as income and savings grow, the importance of diversification also increases.”
There are so many ways to invest at this point, you can potentially design your own journey.
Investing & Trading: Getting Started
To get started, it is important to get your budget in order so that you can save some money. Then, limit trading to be able to set more of your investments for long-term outcomes.
With investing, it is important to learn about the fundamentals of time in the market versus timing the market. “The risk of losing money in the stock market actually goes down over time,” Hopkins says. When you start thinking in terms of 10, 20, 30-year time horizons (and possibly beyond) the daily volatility of the market becomes a lot less scary.
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