Trading and long-term investing can almost be viewed like two sides of the same coin – both approaches attempt to generate returns through targeted investments into the financial markets.
However, the manner in which these returns are generated – and the risks associated with each approach – are what truly set traders and investors apart.
At one end of the spectrum are traders. If this were the story of the tortoise and the hare, they’d be the hare. They attempt to time the markets by buying securities and quickly flipping them for a profit – in other words, buy low, sell high, and repeat over and over again.
At the other end of the spectrum are investors. Investors are like the tortoise, taking a slower, more methodical approach. Investors tend to buy securities with a long-term outlook, creating a portfolio they intend to hold for extended periods of time – ranging from years to decades – through the ups and downs of market cycles until they reach a particular goal.
So, when it comes to trading vs. investing, while it’s difficult to point to one approach as being “better” than the other, there are certain advantages to a long-term, methodical approach. Just ask the tortoise.
The risks of a short-term buy and sell strategy
Today’s traders have access to more tools and information than ever before. However, information isn’t the same as knowledge, and it doesn’t change the risk of trying to time the markets.
At the end of the day, traders need to be right twice: first when they purchase a security and again when they sell it. If they get the timing wrong, they lose money. What’s more, they must do this repeatedly, with different securities and across different stretches of the market cycle. This means any risks that could impact the economy – political upheaval, a natural disaster, even a pandemic – could greatly impact their ability to get this timing right. On top of that, trading comes with its own costs (like short-term capital gains taxed at ordinary income rates, as well as commissions and fees) that long-term investors don’t generate nearly as often.
Too big to fail…until they do
With the recent trading frenzy around GameStop, and before that, Tesla, and before that Bitcoin, it’s important to remember that there’s no such thing as a “can’t miss” trading opportunity. To put this in perspective, in the 17 years between 2000 and 2017, 52% of the companies in the Fortune 500 have gone bankrupt, been acquired or otherwise ceased to exist. In other words, a lot of companies considered sure bets for traders are themselves simply a coinflip.
The benefits of a long-term hold strategy
Unlike trading, investing is a long-term holding strategy. Investors identify a goal and assemble a diversified portfolio which they adjust over time as they progress toward said goal. A common example would be a portfolio held in an Individual Retirement Account (IRA).
With an IRA, an investor is likely looking to generate returns to fund a retirement that might be decades down the road, and they likely aren’t checking or adjusting their holdings on a daily basis.
Studies have shown that a long-term approach offers a more sustainable path to building wealth. Between January of 1971 and May of 2020, if you had picked a random day to buy and trade, you would have had a 52.3% chance of generating a profit – another flip of the coin. However, a longer-term strategy of just 65 days would up those odds to about 65%. At just one year, those odds were almost 72%, and at ten years they reached nearly 94%.
Five steps you can take to help build a successful investment strategy
Even with the odds in your favor, there are distinct actions you can take to help improve your chances of being successful with a long-term investment strategy. It’s important to:
- Understand your investment objectives, risk tolerance and time horizon. Before you start investing, know what it is you’re investing toward, how much time you have on your side, and how much risk you’re willing to take on to reach that goal.
- Develop an asset allocation profile that provides diversification among assets and asset classes. Don’t put all your eggs in one basket. That way, when certain securities underperform due to market conditions, your portfolio may still generate returns from other holdings.
- Rebalance your portfolio regularly (quarterly, yearly, etc.) to return to your target asset allocation. Don’t let market swings lead you to become overly weighted in any one type of security – for example, purchasing additional shares of a stock performing particularly well.
- Be aware of the taxes and fees that impact your returns. Different approaches to investing come with different fees and tax consequences. Make sure you know what you’re paying for, and why you’re paying for it.
- Practice patience and be prepared for the long-haul. Remember the tortoise and the hare. Investing should be considered a slow and steady march toward your goals.
Working together toward your financial well-being
At PNC Investments we utilize a goals-based approach to financial planning. You can count on our Financial Advisors to take the time to understand you, your family, your needs, goals and more. Then they’ll use that information to provide you with a personalized investment strategy.
For more information on investing, or to discuss your personal financial plans in more detail, contact a PNC Investments Financial Advisor, today.