Many people associate the stock market with risky bets. It’s a way to either make a lot of money or lose a lot of money. That’s why the stock market gets wrongly associated with gambling, even to some people who participate in it. But there’s a big difference between buying a stock to make money quickly and buying a diversified index fund you intend to hold for decades. The former is trading, the latter is investing.
When people compare the stock market to gambling or think of it as a get-rich-quick scheme, what they’re talking about is trading. But investing bears no resemblance to gambling; neither is it a get-rich-quick scheme. It’s the safest and surest way to grow your money and beat inflation over the long term.
With easy-to-open brokerage accounts, commission-free trades and the ability to buy fractional shares, trading is easier than ever. Anyone can open an account and with as little as $5 buy shares of their favorite stock. But just because trading is easy, doesn’t mean you should do it.
Trading and investing represent two completely different approaches to the stock market. Understanding the difference can help you make the right choices as you decide to put money into stocks for the first time.
Here are the differences between trading and investing:
Get Rich Quick v. Get Rich Slowly
Traders aim to make money fast. Some traders may hold their positions for weeks. Others hold them for days, hours, minutes or even seconds. It’s all about exploiting short-term price fluctuations to make money. Investing is a long game. Investors know they won’t get rich overnight by investing in index funds. Investing is a long, painstaking path to wealth that requires much more patience.
A market crash can quickly wipe out traders who concentrate their money in a handful of stocks or a sector of the market. Investors shrug off temporary market crashes and keep buying over the course of their life. Investors don’t care if the funds they invest in are down on any given day. Only long-term performance matters.
Traders try to beat the market. Some succeed, but most fail. Investors know it’s almost impossible to beat the market over the long term.
Tax Burden
Trading has greater tax consequences if you use a taxable brokerage account. If you hold an asset for less than a year, your gains are subject to regular income tax rates, which can range from 10% to 37%. Holding an asset for a year or more means you pay long-term capital gains rates, as low as 0% or only as high as 20%.
Investing is generally a tax-efficient activity, even if the funds you invest in aren’t tax-efficient, because of the more favorable long-term capital gains rates. Investing in index funds over the long term will mean you pay fewer taxes than someone who frequently buys and sells. And because investors are focused on the long term, they are more likely to use tax-advantaged retirement accounts to reduce their taxes even more.
Involvement
Trading requires you to constantly check the prices of the stocks or other assets you’re dealing with. It’s much more hands-on and the constant activity it requires means more can go wrong. It also means a lot more stress. Traders must constantly monitor their positions and decide when to buy and sell. When investing, you shouldn’t look at your accounts often because what happens on a day-to-day basis doesn’t matter in the grand scheme of things.
While investors ignore headlines, traders are glued to them. Market news and global events influence their actions. Traders holding a Russia ETF in February before the invasion of Ukraine would have seen that position drop almost 100% in value unless they knew to sell. Traders might exploit commodity trends, like buying copper if supply tightens and prices are expected to rise.
Trading can be a dangerous entryway for those new to the stock market. Big wins early on due to random outcomes can create a false sense of confidence that can cause traders to take on even more risky bets. Anyone uninitiated in the stock market is better off putting money into a diversified index fund.
While traders need to concern themselves with the financials of individual companies and know how to analyze market information, investing doesn’t require expertise. Investors only need the basic knowledge required to purchase shares of total market funds regularly and forget about it.
Risk
You’re much more likely to lose money by trading as opposed to investing. Many traders treat the stock market like a casino. They attempt to secure huge gains in short periods of time. Investors know the odds aren’t in their favor, so they don’t try.
Traders often deal in riskier assets. While investors may put all their money in simple diversified mutual funds or ETFs, traders are more likely to buy and sell individual stocks, currencies, commodities, active ETFs and more complex products that use leverage.
While investors believe in a diversified portfolio, traders may take an outsized short-term position in a single stock or fund. The more that’s concentrated in a portfolio, the greater the risk of losing money.
Investing is a Safer Path to Wealth
I’ve presented the features of trading and investing as absolute, but they can overlap. Some inventors do buy single stocks or commodities with a long time horizon in mind. People who invest in riskier assets may need to rely more on fundamentals and data. But investing in a diversified portfolio of index funds doesn’t require taking on risky bets or deep knowledge of how markets work. It only requires basic knowledge anyone can obtain and the right mindset.
Anyone new to the stock market should have their eye on a long-term goal and invest accordingly. Those who see the stock market as a get-rich-quick scheme are bound to be disappointed. Trading can be a much riskier activity and cause you to lose money. If trading individual stocks still interests you, only put as much money as you can afford to lose into a trading portfolio, and keep it separate from your serious long-term accounts.