Investing should be dull. It shouldn’t be exciting. Investing should be more like watching paint dry or grass grow. If you want excitement, take $800 and go to Las Vegas… It is not easy to get rich in Las Vegas, at Churchill Downs, or at the local Merrill Lynch office.”
I am a very dull investor. The majority of my friends that like to talk about investing (which, let’s face it, is not the majority of my friends) are not like me. They often talk about day trading, and penny stocks, and trading options on margin. If that is the kind of information you are looking for here, you have probably come to the wrong place. My investing philosophy is very different.
Day trade: the act of buying and selling a stock within the same day.
Penny Stocks: typically trades outside of the major market exchanges at a relatively low price. These stocks are generally considered highly speculative and high risk.
Options: contracts that grant the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date.
Margin: borrowing money from a broker to purchase stock.
Don’t get me wrong. I’m not saying there is anything wrong with any of these methods, under appropriate circumstances. I’m also not saying I will never discuss them on this blog, or that I never do them. I mean, I don’t, but that’s because I am lazy as all get out when it comes to investing.
Why I Don’t Day Trade
People who day trade or take a flier on a stock have to work for it. If they have any hope of choosing a winner, they *should* do a lot of research into the investment, the management of the company, the market, the prospectus, etc. That sounds soooo boring to me!
“Take a flier” is the slang term for a decision to invest in highly speculative investments.
Of course, you could always do all of these things without doing your research, but doing so is just a different form of gambling. Personally, I’d rather save my gambling money for a trip to Vegas. $800 in Vegas can buy you a pretty good weekend – a nice room, some great restaurants, a show, and still a few dollars to hit the tables.
Trading vs Investing
Trading and investing are both methods of attempting to profit in the financial markets. However, they are very different in terms of how involved one has to be with their money.
All of the terms above are most closely associated with trading. Trading involves frequent buying and selling of investment instruments such as stocks and commodities. The goal of trading is to generate returns that beat long-term investors by buying when the investments are cheap and selling when the price has gone up.
The potential upside of trading vs investing is the possibility of high returns compared to, say, the stock market’s return as a whole. And that sounds great! But unfortunately, it doesn’t happen that way for many (most?) people.
The downside, in my opinion, is that trading takes a lot of effort. It is very active. You have to choose your investments, and determine the price you are willing to pay for them, and the price you are willing to sell them at, and whether you will sell them by a given date if they haven’t risen in price enough, yada yada yada. There are a lot of things to consider.
Investing is Different
Investing, on the other hand, is the gradual building of wealth over an extended period of time. This can be accomplished through what is known as a “buy and hold” strategy: purchasing a type of investment and keeping it for years or decades. The investments could be stocks, mutual funds, bonds, or other investment instruments.
Buying and holding an investment allows the investor to take advantage of a few things. First, investors can use the miracle of compound interest to achieve large long term gains. Depending on which investments are chosen, a long term investor might benefit from dividend payouts and stock splits. Investors can also use the lower long term capital gains tax rate, which means paying less taxes in the long run.
My Investing Philosophy is “Buy and Hold”
Buy and Hold investing is not exciting. It’s as boring as watching paint dry. In fact, I pay almost no attention at all to my investments. I told you I was lazy, remember? Instead of checking on my investments every day and fretting over whether I’ve made any money, I only check them once per year.
Oh, I might see that the stock market has gone up or down if it’s in the news. But I hardly ever check the actual value of my investments. And I only add up all of my money once per year to see how I did over the previous year.
The potential downside of this method is that I often buy investments when they aren’t at their lowest recent price. I might buy an index fund for $100 per share one month, $90 the next, and $110 the third month. So I’m definitely not getting the absolute best possible price for my purchases.
The upsides, though, make it worth it to me. I rarely pay transaction fees, since I’m not constantly buying and selling. My investments cost a set price each month (low, because I use a low-cost online brokerage) and that’s it. I also don’t pay any capital gains taxes now because I’m holding the investments, and when I do go to sell them they will all fall under long term capital gains rules so I will pay less then, as well.
And of course, I do basically nothing to make this happen. At the same time that I check my investment totals each year, I also decide on whether to stick with my current investments or start buying something new. That will take a few hours of reviewing options, but my total hands-on time each year is probably only about 3-4 hours.
Which method is better?
Since personal finance is personal, there really isn’t a “better” method. If trading is interesting to you, it’s probably better to do that than it is to, say, “invest” in Beanie Babies. But personally, I believe that the passive technique of investing in index funds and letting the stock market do its thing without input from me is the best method for me. The investment returns I’ve earned with this method are sufficient to meet my goals, and I don’t have to think about it.
And Warren Buffett agrees with me. In 2007, the greatest investor in American history, Warren Buffett, made a ONE MILLION DOLLAR bet that an index fund tracking the S&P 500 would have better returns over a decade than an actively managed hedge fund. Protégé Partners took the bet and picked five investments that they thought would beat the S&P 500. And these are actively managed funds, so they’ve been able to adjust over the last almost ten years while the S&P 500 has followed the same passive indexing strategy. So you’d think the actively managed funds would be higher overall because of their ability to adjust, right?
Well, the bet is about to end, and Warren Buffett is not only about to win the bet, he’s about to win it big time. While the Protégé Partners investments have (as of March 1st, 2017) returned $220,000 in a little over 9 years, the S&P 500 has returned about $854,000. Part of that is simply because the index fund has performed better, and part is because of those transactions fees I talked about. Index funds are cheaper to maintain than actively managed funds, so you keep more money in your pocket.
And if the folks on Wall Street who do this for a living can’t pick winning stocks, who am I to think that I would do any better? So that is why I buy and hold index funds. It’s easy, it’s simple, and in the end I get a better return. Winning all around!
Which do you prefer, trading or investing? Why?
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